Forbes: Planning Checklist For S. Corp. Shareholders
When income is distributed to stockholders of U.S. corporations there are two levels of taxation: one at the corporate level (as adjusted net income) and one at the stockholder level (as dividend income). If the corporation and shareholders elect, the distributions to stockholders are treated as adjusted net income to the stockholder and the corporation pays no income taxes. This election is limited to small business corporations (a so-called S. Corp.) which are defined as a domestic U.S. corporation, which is not an ineligible corporation (a financial banking or DISC corporation), which does not have more than 100 eligible shareholders, all stockholders must be eligible persons or entities, and has only one class of stock outstanding.
Just as gaining S. Corp. status is a tax savings to shareholders, losing S. Corp. status has significant tax costs. Estate plans for S. Corp. shareholders have to be carefully drafted and executed in order to not inadvertently lose the S. Corp. status. Here is a quick checklist for advisors and stockholders of the possible pitfalls of S. Corp. status:
Check residency or citizenship status of each prospective S shareholder and each individual who is named in estate plan documents as an S corporation stock beneficiary, as well as contingent and residuary beneficiaries.
For purposes of ensuring that a grantor trust qualifies as an S shareholder, confirm that the grantor owns the entire trust.
Institute a plan to review testamentary trusts prior to the expiration of the 2-year holding period to make sure that the trust qualifies beyond the 2-year period as an S corporation shareholder or that the stock is transferred to a permitted shareholder within the holding period.
Check for issued preferred stock as well as authorized but unissued preferred stock. Review the articles of incorporation, by-laws, applicable state laws, and binding agreements related to distribution and liquidation rights to determine any second class of stock circumstances.