S Corporation Agreement
S corporations are corporate business entities that have elected to be taxed under Subchapter S of the Internal Revenue Code. The Internal Revenue Service requires that businesses first meet a set of strict requirements before granting the business S corporation status. An S corporation agreement between the shareholders can help plan for potential problems.
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S Corporation Advantages
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Two primary advantages to S corporation status are limited liability and pass-through taxation. Like a standard corporation, S corporation shareholders are only liable up to the extent of their business investment in the company for the debts and obligations of the business; they are not personally liable. Unlike standard corporations, however, S corporation profits are not taxed at the corporate level; instead the profits pass-through the entity. The shareholders then report any distributions of those profits on their individual income tax forms.
Strict Requirements for S Corporations
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An S corporation can lose its status if it does not meet the relevant IRS guidelines, according to Entrepreneur.com. As of 2011, S corporations can only have 100 shareholders; the shareholders must generally be U.S. citizens and cannot be business entities like other corporations or partnerships. The business itself must also be a domestic corporation, formed under relevant state laws. It can only have one class of stock.
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S Corporation Shareholder Agreements
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Losing or revoking S corporation status can have serious financial ramifications for the company. To protect against potential problems, an S corporation shareholder agreement can be used. This agreement sets forth the duties and obligations of each shareholder. If a shareholder does something that puts the S corporation status at risk, the agreement can provide remedies to the business or the other shareholders. Common sections in the agreement include a right of first refusal, which requires shareholders to offer shares to the business first before entertaining other offers, and provisions to handle the death of a shareholder, such as requiring the deceased shareholder's estate to sell back the shares rather than allow them to pass through inheritance.
Drafting Considerations
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An S corporation agreement must meet the individual needs of the business and the shareholders. Forms and templates are available, but the language in those documents may not be suitable for every situation. S corporation agreements affect the legal rights of the parties involved and should be drafted by a legal professional.
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