Part 3: S-Corp Shareholder Rules — Who Can Actually Own an S-Corporation?

👥 S-Corp Shareholder Rules — Who Can Actually Own an S-Corporation?

One of the most misunderstood parts of Subchapter S is the set of shareholder eligibility rules.
Even if a business is perfectly structured for an S-Corporation, the election can fail or terminate if the stock is ever transferred to an ineligible owner.

1️⃣ Who Counts as an Eligible S-Corp Shareholder?

The IRS keeps S-Corporations “closely held” by strictly defining who can own shares.
The following owners are fully eligible in 2025:

• U.S. citizens
• U.S. resident aliens (green card or substantial presence test)
• Certain estates of deceased shareholders
• Qualified trusts (QSST, ESBT, grantor trusts)
• Tax-exempt 501(c)(3) organizations (limited scenarios)

These restrictions exist to prevent complex or foreign-controlled ownership that could disrupt the flow-through structure of Subchapter S.

2️⃣ Trusts Allowed to Hold S-Corp Stock

Trusts can own S-Corp shares, but only if they fit into specific categories.
Here are the trust types allowed in 2025:

📌 Grantor Trusts

A revocable living trust (common in estate plans) is generally allowed because the owner is treated as the direct owner.

📌 QSST — Qualified Subchapter S Trust

• Only one income beneficiary
• All income required to be distributed
• The beneficiary reports all S-Corp items

📌 ESBT — Electing Small Business Trust

ESBTs are more flexible and can have multiple beneficiaries, including charities.
They pay income tax on S-Corp income at the trust tax rates, which are compressed.

3️⃣ Who Is NOT Allowed as an Owner?

The following owners are not allowed and will immediately terminate S-Corp status if they receive stock:

• Nonresident aliens (NRA)
• Partnerships
• LLCs (even single-member LLCs)
• C-corporations
• Foreign trusts or foreign entities

Transfers to these owners are the most frequent cause of unintentional termination — especially during fundraising or family transfers.

4️⃣ Family Aggregation & the One-Shareholder Rule

The IRS allows certain family groups to be counted as one shareholder for the 100-shareholder limit:

• A married couple
• Their children, grandchildren, parents, and grandparents

This rule is useful for multi-generation family businesses that want multiple owners without risking the 100-owner limitation.

5️⃣ How Transfers Can Terminate S-Status

S-Corp elections terminate the moment shares end up in the wrong hands. Common termination events include:

• Founder moves abroad and becomes a nonresident alien
• Shares placed into a trust without QSST/ESBT election
• Partner entity or LLC accidentally receives stock
• Estate administration distributes shares improperly

6️⃣ EA Checklist — Safe Ownership Structure

If you’re advising a business or reviewing an S-Corp setup, confirm the following:

• All owners are U.S. individuals or qualifying trusts
• No owner has become a nonresident alien
• Business has proper QSST/ESBT elections on file
• No entities (LLCs, partnerships, corporations) hold shares
• Family aggregation rules are used only when appropriate
• Cap table is updated after every ownership change

A proactive shareholder eligibility review once a year prevents painful and costly IRS surprises.

7️⃣ IRS Reference Links

8️⃣ Related EA Tax Guide Articles

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