While there are many advantages to structuring your business as an S-Corporation, it does limit the types of entities that can become shareholders. The benefits of incorporating far outweigh this restriction, but it is important for you to know exactly which entities are permitted to take a seat the table.
After all, your shareholders play a critical role in avoiding double taxation on your income. Your company passes its income, losses, credits and deductions to your shareholders, who then report this flow-through of income and losses on their personal tax returns. You should note that your company is still subject to taxation on passive income and some built-in gains.
Perhaps even more significantly, the IRS may declare your S-Corporation null and void if it discovers you have issued shares to prohibited entities. This means the IRS will enforce the very scenario you chose this structure to avoid: double taxation. It will impose taxes on both the corporate and individual shareholder level.
Due to the aforementioned reasons, you should take into account which types of entities are worth the time investment when you are in the process of seeking out and vetting potential shareholders.
Who Makes the List and Who Does Not?
In order to become an S-Corporation shareholder, you must be a United States citizen or permanent resident. The IRS permits individuals, trusts with individuals are beneficiaries, some voting trusts, qualified subchapter S trusts, grantor trusts, revocable trusts created as part of an estate and testamentary trusts created by a will to purchase shares. Additionally, estates of deceased individuals that owned shares prior their passing can maintain ownership through the probate process.
Business trusts, foreign trusts, partnerships and C-Corporations are forbidden from becoming shareholders in an S-Corporation. As mentioned previously, nonresident aliens are also out of the running.
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