Subchapter S Corp Restrictions
The S corporation (or small business corporation) is a special category of the regular C corporation that comes into existence under Subchapter S of the Internal Revenue Code. The shareholders of the corporation make an election to have the corporation's income and losses taxed on their individual tax returns instead of on a corporate tax return. This special tax treatment is only available to corporations that meet certain requirements as set by the Internal Revenue Service (IRS).
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Number of Shareholders
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Internal Revenue Code section 1361(c)(1) restricts an S corporation ownership to 100 shareholders or less. There are two caveats in satisfying this restriction: A husband and wife can be considered one shareholder; and members of the same family can be considered one shareholder. All other individuals are treated as separate shareholders. This is in direct comparison to a regular corporation which can have an unlimited number of shareholders, particularly if it is a public corporation that is listed on a stock exchange.
Type of Shareholder
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An S corporation can only have individuals and certain types of estates and trusts as shareholders. In addition, those individual shareholders must be U.S. citizens or resident aliens. A regular corporation, in comparison, can have other corporations, partnerships, LLCs or any other entity type as a shareholder and can have anyone in the world buy its stock from a stock exchange.
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Class of Stock
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An S corporation is restricted to having only one class of stock (usually common stock). The S corporation's stock must confer identical rights to distribution and liquidation proceeds to all shareholders. The stock can have different voting rights -- where some shareholders have more of a say in affairs than others -- but must have one level of equitable value.
Ineligible Types
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Only a domestic corporation can make a Subchapter S election. Further, certain types of corporations are prohibited from making the election, including banks and thrift institutions that use the reserve method of accounting for bad debts; insurance companies subject to tax under Subchapter L; corporations that have elected to be treated as possessions corporations; and domestic international sales corporations (DISC) or former DISCs.
Tax Year
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An S corporation must adopt or change to a tax year that is approved by the IRS. The ordinary type of tax year that an S corporation will use is a calendar year; however, there are other types of tax years that can meet this requirement in special circumstances. The instructions to part two of the election form provide tests for different tax year options.
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