Because S corporations are “pass-through” entities, they are restricted in the types and number of shareholders they may have. In general, only individuals, estates and certain trusts qualify to own S corporation stock. Additionally, S corporations may not have more than 100 shareholders; however, for purposes of determining the number of shareholders, all “members of a family” are treated as a single shareholder. The term “members of a family” is defined under Subchapter S of the Internal Revenue Code (IRC) to generally include all family members within six generations, as well as their spouses and ex-spouses. Failure to adhere to these requirements will cause an inadvertent termination in the entity’s S election. In the case where an existing shareholder proposes to transfer his/her shares, whether by gift, sale or otherwise, the agreement should require the shareholder to first notify the institution of the proposed transfer and all material terms. This will allow the institution to verify that the transferee qualifies as a shareholder under the terms of the shareholder agreement.
