Watch Out For Two Classes of Stock in S Corps!
Many farm operations use an S corporation. These corporations legally are the same as any other regular corporation, however, for income tax purposes, the shareholders have made an election to be taxed similar to a partnership.
One of the requirements of an S corporation is that there can only be ONE class of stock. You cannot have common and preferred stock in an S corporation. You cannot pay dividends on a non-pro-rata basis. This can trip up our farm clients. Many times, there will be children that own shares in the S corporation and the corporation will pay a dividend to the parents and forget to pay a dividend to the children on a pro-rata basis. If audited, the IRS can argue that this is a separate class of stock and disallow the S corporation.
The S corporation, however, is allowed to have both voting and non-voting stock. This allows the parents to transferred non-voting shares to the children and grandchildren and keep control of the operation by retaining the voting shares.
If you have an S corporation, please make sure to follow the rules when it comes to not having a second class of stock.
Paul Neiffer is a certified public accountant and business advisor specializing in income taxation, accounting services, and succession planning for farmers and agribusiness processors. Paul is a principal with CliftonLarsonAllen in Walla Walla, Washington, as well as a regular speaker at national conferences and contributor at agweb.com. Raised on a farm in central Washington, he has been immersed in the ag industry his entire life, including the last 30 years professionally. Paul and his wife purchase an 180 acre ranch in 2016 and enjoy keeping it full of animals.
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