Stock Options in an S Corporation
- Stock options are available with an S corporation.profit/loss image by Warren Millar from Fotolia.com
An S corporation is a creation of the U.S. Internal Revenue Service (IRS). While legally organized as a typical corporation, with all the documentation usually necessary, an S corporation primarily differs in its taxation rules. Instead of facing corporate tax rules, profits are distributed to stockholders, who can then use individual taxation rates. Some stock restrictions cause an S corporation to follow some rules different from other corporations. Stock options, while not highly restricted, should be considered carefully.
Maximum Number of Stockholders
- An S corporation must have no more than 100 stockholders. For many small businesses, this restriction is not a serious problem. However, owners should understand this restriction when considering the number of individuals who may qualify for stock options. Should an S corporation expand over time to approach the maximum, it must carefully control the number of people to whom it offers stock options.
Only One Class of Stock
- Since an S corporation can authorize and issue only one class of stock, some of the more "creative" stock option programs will be unavailable. For example, some large corporations may offer options for common, but non-voting stock, or for preferred stock. These choices are unavailable to S corporations as their offering is typically standard common stock with all its rights and privileges.
Authorize Sufficient Shares
- This is important for S corporations but sometimes overlooked. An S corporation often authorizes and then issues all of its stock to a few "owners." In the future, it may want to offer stock options to one or more key employees. However, if there are no authorized but unissued shares, it may have to transfer some of its own stock per the option rules it has established. This dilutes the compnay's ownership percentage and may also bring unwelcome tax issues. Incorporators should authorize sufficient shares to have the ability to offer others stock options in the future without hurting their own shareholder positions.
Stockholder Citizenship Rules
- Foreign investors cannot buy stock in an S corporation. IRS regulations allow only U.S. citizens or resident aliens to own stock in the corporation. This rule is not meant to be prejudicial. Since all profits are not subject to corporate taxes, but are "passed through" the company to individual stockholders, foreign nationals, not subject to U.S. individual income taxes, cannot therefore own S corporation stock.