Two siblings inherit a family construction business and want pass-through tax treatment. They issue 60% voting common to the active sibling and 40% nonvoting common to the silent one, then admit a few friends. One friend lives in Mexico City on a tourist visa. The plan looks clean, until the nonresident alien signs the cap table. That single shareholder kills the S election before Form 2553 ever gets filed.
The S corporation is a federal tax election layered on top of a state-law corporation. The state sees an ordinary C corp; the IRS sees a pass-through. Subchapter S is narrow on purpose, eligibility rules are tight enough to keep public companies and foreign capital out of the regime.
A corporation must clear all five tests, every day of the year. A failure on any single requirement terminates the election immediately.
1. Domestic corporation. Organized under the laws of one of the 50 states or DC. Foreign corporations are barred.
2. ≤100 shareholders. Members of the same family (a common ancestor, lineal descendants, and spouses, going back no more than six generations) count as one shareholder.
Common mistakes
- Counting families as multiple shareholders. 105 shareholders all in one family across four generations is one shareholder, not 105. The cap is 100 family/individual units, not 100 names.
- Treating voting differences as a second class of stock. 100 voting and 100 nonvoting shares with identical economic rights = one class. Only differences in distribution or liquidation rights create a second class.
- Filing Form 2553 after the deadline and assuming current-year effect. Late filings are effective the next tax year, not from the filing date. Late-election relief under Rev. Proc. 2013-30 may be available but is not automatic.
Bottom line
- Eligibility: domestic corporation, ≤100 shareholders (a family counts as one across six generations), only individuals, estates, certain trusts, and 501(c)(3)s allowed.
- Barred shareholders: corporations, partnerships, other S corps (except QSubs), nonresident aliens, and most IRAs; eligible trusts are grantor, voting, QSST, and ESBT.
- One class of stock: voting differences are fine, economic differences (preferred distributions, liquidation preferences) are not; the straight-debt safe harbor protects ordinary shareholder loans.
- §1362 election: file Form 2553 with unanimous shareholder consent. Effective the current year if filed by the 15th day of the 3rd month, otherwise the next tax year.
Exam shortcut
Run the five-question eligibility screen: (1) domestic corporation? (2) ≤100 shareholders counting families as one? (3) every shareholder an individual / estate / qualifying trust / 501(c)(3)? (4) one class of stock with at most voting-only differences? (5) not a barred corporation type? Any "no" kills the election. For Form 2553 timing, the rule is "15th day of the 3rd month," March 15 for calendar years.
The full lesson (about 2,247 words, 15 min read) adds 1 worked example, all 4 common mistakes, a self-check, free in the app.
Learning objectives
- V.C1
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