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.