A corporation's classification as an S corporation by the Internal Revenue Service (IRS) is a privilege extended to small corporations that meet certain special requirements outlined by Subchapter S of the Internal Revenue Code. The most significant requirements concern who is allowed to be a shareholder of the company. A corporation's Subchapter S tax status will be canceled automatically by the IRS if the corporation's shares are transferred to an ineligible shareholder, which will often have severe tax consequences. It is considered a best practice for S corporations to have stock transfer restrictions built into the company's bylaws or formalized through a separate buy-sell agreement that prohibits the transfer of stock to third parties without approval to protect the corporation's Subchapter S election.
1. Follow the corporation's explicit stock transfer procedures. Refer to the corporation's bylaws or separate buy-sell agreement between shareholders. Most well-run S corporations will restrict stock transfers to preserve the corporation's Subchapter S election from revocation through the accidental transfer of stock to ineligible parties. The corporation may require approval of third parties to whom you wish to transfer the stock or may prohibit transfer altogether and require you to sell your stock back to the corporation. The specific stock transfer procedures that are in effect for the S corporation trump any general procedures to make the transfer.
2. Draft a stock transfer agreement. Establish the terms of the transfer, which can include a sale of the shares in exchange for money or a gift of shares for no consideration. By law, an S corporation is only allowed to have 100 shareholders or fewer. Typically, an S corporation is privately held and not public, particularly because of the stock ownership restrictions. Shares cannot be bought and sold on the open marketplace using a stock exchange and a broker. The parties to the transfer of S corporation shares agree to terms privately and memorialize the agreement as a written contract.
3. Execute the agreement and exchange consideration. Both parties should sign the stock transfer agreement. If the S corporation issues paper stock certificates, the current owner should sign them over to the new owner. If the shares are being sold, the buyer should transfer payment to the seller.
4. Record the transfer in the corporation's stock ledger. An S corporation is required to maintain an accurate record of stock ownership in the company. The secretary of the board of directors should make note of the date of the transfer and the sales price, and record the contact information and Social Security number of the new owner.
5. Prepare a consent to the S corporation election. One of the requirements for Subchapter S status is that all shareholders consent to the election in writing. The consent form is a notarized declaration that the shareholder agrees that the company should be taxed under Subchapter S. Have the new shareholder sign the consent form, and file it with the corporation's records.
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