Most S companies with multiple shareholders should, for a simple reason, have a written shareholder pact. A shareholder contract reduces the likelihood and costs of a shareholder who, voluntarily or unintentionally, does something that terminates the “S” status of Company S. As noted above, companies must meet the criteria set by the IRS to become an S company. Moreover, to become an S-body, a company can only have a limited number of shareholders. In addition, shareholders may only be made up of individuals, trusts and rebates or certain tax-exempt organizations. Finally, partnerships, certain financial institutions, capital companies, insurance companies and non-resident foreigners cannot be shareholders of S Corps. Given the IRS`s authority and favourable decisions in this area, it appears that most reasonable shareholder agreements for valid commercial purposes would not be taken into account in the analysis of whether a company has a second class of shares and, therefore, should not cause heartburn to purchasers in a Section 338 (h) transaction (10). However, in practice, purchasers often express their concerns about the provisions of shareholder agreements and take advantage of these concerns to request an increase in the resources held in trust to cover the potential tax burden if the S election is cancelled and/or structured. The vast majority of S companies with more than one shareholder should have shareholder agreements. To achieve this goal, a shareholder pact requires a shareholder to first offer his shares to other current shareholders. In addition, a shareholder who sells his shares to an external party must obtain the agreement of the other shareholders. In most cases, a shareholder pact can prevent the sale of shares, set penalties for shares and set terms for the sale of shares. A regular business can make a special tax choice with the IRS if the company complies with the guidelines of sub-chapter S of the internal income code.
A sub-chapter S choice allows a small business to be taxed as an unsteped business, so the business is not required to pay corporate income taxes.