Like any other corporation, an S corporation can issue stock. But to maintain the special tax status that is the primary advantage of the "S corp.," the company can issue only one kind of stock, and it must be careful in tracking who becomes a shareholder and how many shareholders there are in all.
An S corporation -- named for the subchapter of the tax code that applies to such companies -- has a primary advantage over a traditional corporation: It doesn't pay corporate income taxes. Instead, all profits pass to the shareholders in proportion to their stake in the company, and each shareholder pays personal income taxes on that money. Federal law intends the S corporation structure to be used mostly by small business, so it sets strict rules on stock issued by S corps.
One Stock Class
Many traditional corporations issue different classes of stock. A share of preferred stock, for example, might guarantee a higher dividend or convey a greater ownership stake in the company than a share of common stock. But an S corp can issue only one class, and each share represents an equal portion of ownership. However, federal law allows an S corp to assign different voting rights to different levels of shares within that one class of stock.
To maintain S corporation status, a company cannot have more than 100 total shareholders. A married couple can count as one shareholder for the purposes of this provision. Members of a single family can count as a single shareholder, too, as long as no shareholder is -- in the words of the federal tax code -- "more than 6 generations removed" from the youngest member of the shareholder group.
Only individuals, estates and certain trusts can own shares in an S corporation. All individuals must be U.S. citizens or legal residents. An estate must be that of a citizen or legal resident, and the beneficiaries of eligible trusts must also be citizens or legal residents. Tax law allows three types of trusts to hold shares in an S corp: grantor trusts, qualified subchapter S trusts and electing small business trusts.
If an S corp distributes stock to more than 100 shareholders, or to an ineligible shareholder, the company can lose its S corp status. This will force the company to pay corporate income taxes, and it will change the way profit distributions to shareholders are taxed. Once a company loses S corp status, it can't regain that status for five years.
Cam Merritt is a writer and editor specializing in business, personal finance and home design. He has contributed to USA Today, The Des Moines Register and Better Homes and Gardens"publications. Merritt has a journalism degree from Drake University and is pursuing an MBA from the University of Iowa.