Eligible S Corporation Shareholders
By Section 1361(b)(1) provides a corporation can qualify for taxation as an S corporation only if none of its owners are nonresident aliens, foreign entities, partnerships, corporations, or ineligible trusts. An S corporation shareholder generally must be a U.S. resident individual, but there are several exceptions.
Section 1361(b)(1)(B) allows decedent’s estates, eligible trusts, and certain charitable organizations to own S corporation stock. The trusts eligible to own S corporation stock include grantor trusts under Subpart E (which are disregarded as separate from their grantor for income tax purposes), electing small business trusts (ESBTs), certain voting trusts, and qualified subchapter S trusts (QSSTs). Trusts must have specified provisions and beneficial owners to be ESBTs or QSSTs.
Corporations generally cannot own S corporation stock. However, an S corporation can be the sole owner of another S corporation if an election is made for the subsidiary to be a qualified subchapter S subsidiary (QSub). A QSub is disregarded for income tax purposes as separate from its S corporation parent (although it does remain regarded for state law and employment tax purposes).
A grantor trust may own S corporation stock as a disregarded entity provided the grantor is an eligible shareholder itself. Similarly, a limited liability company that is disregarded as separate from its owner pursuant to Treas. Reg. § 301.7701-3(b)(1)(ii) is a permissible S corporation shareholder if its owner is a permissible S shareholder. See, e.g., PLR 201016025.
Where an S corporation violates the ownership requirements, its S election terminates, and the corporation becomes a C corporation. See IRC § 1362(d)(2). However, Section 1362(f) provides relief for certain inadvertent failures.
John G. Hodnette is an attorney with Fox Rothschild, LLP in Charlotte.