Q-1:

Subject: S-Corp single class of stock question

 

An S-Corporation initially issues 1000 shares to its single shareholder for $1/share. Later, it issues 1000 shares for $20/share to another

shareholder. Does the different price per share constitute a second class of stock (assuming all shares receive an equal distribution of profits)? How about if all 2000 shares were issued at initial capitalization (that is, one shareholder paid $1/share and another paid $20/share, all at startup)?

A-1:

What the stock sells for doesn't determine the class, as long as all ownership rights are the same for both batches.

Here is the description from page D-2 of the Small Business QuickFinder Handbook:

One Class of Stock

An S corporation can have only one class of stock. It is treated as having only one class of stock if all outstanding shares possess identical rights to distribution and liquidation proceeds. Differences in voting rights are allowed as long as the other requirements are met. For example, issuing nonvoting common stock or paying bonuses to key employees does not create a second class of stock. (Letter Rul. 200118046)

Caution: If not properly structured, a shareholder loan to an S corporation can create a second class of stock and disqualify S status. If the debt is convertible to equity, or if terms of the loan are contingent on profits or dependent on the borrower’s discretion, the loan may be considered a purchase of a second class of stock.

 Q-2:

Is the shift in capital immediately taxable (as, I understand, it would be were the company a partnership)? Or do you wait until liquidation, and get a (possibly long-term) capital gain?

 
A-2:

 You really need to be working directly with a professional tax advisor who can explain how corporations work because you seem to be very mistaken on some basic accounting and tax concepts.

If you sell some of your shares to another person, you will have a capital gain to report on your 1040.

If the corp sells new stock to a new person, that isn't a taxable event and has no tax consequences. 

That new stockholder will need to keep track of his/her basis in the stock for proper tax treatment of corp events, as does the original stockholder.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 6/07/2006 10:04:00 AM Send this post: