An S corporation is a state registered C corporation with a special tax status granted by the Internal Revenue Service. This means that an S-corp has to comply with the regulations of the state where it is incorporated as well as meet ownership and standards established by the IRS. Treasury stock are shares issued by a corporation that it either repurchased from a shareholder or issued but did not sell. Prior to obtaining treasury stock, an S-corp should evaluate state and IRS regulations to ensure it can hold those types of securities.
Benefits of S Corporations
S-corp shareholders’ personal assets are generally protected from business liabilities and business profits are not taxed twice. Instead of a business being taxed when it earns income and shareholders being taxed when they receive distributions, S-corp shareholders are only taxed on their share of a business’s annual income.
Why Have Treasury Stock
Unlike ordinary stock, treasury shares have no voting rights and do not give a business the right to dividends. An S-corp may want treasury stock to protect against takeovers or so it has an option to raise funds in the future by selling the treasury shares to investors.
State Law and Treasury Stock
Like a C-corp, an S-corp is subject to state law, including laws on whether the corporation can hold treasury stock. Some states, such as Nebraska, prohibit a company from holding treasury stock. Other states, such as Illinois, permit such ownership. Those states that do permit a business to own treasury stock may also have rules governing whether a corporation’s current shareholders have a right to acquire company shares before a third party buyer when the business resells its stock. If you are working on behalf of an S-corp considering obtaining treasury stock, review the corporate code of your state to ensure you can issue the shares and what conditions are associated with that stock.
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S-corps are permitted to have only one class of outstanding stock. This means that each issued share of stock has the same rights regarding voting power and a shareholder's ability to receive distributions of the business's income through dividends. It would appear that treasury stock would violate this one class rule, since it neither has voting rights nor can receive dividends. However, these S-corp regulations only relate to “outstanding” shares, or stock owned by shareholders. Since the treasury stock is owned by the S-corp, it does not violate the one class rule. Therefore, so long as the state permits a corporation to hold treasury stock, an S-corp can as well.
One question that might arise is whether an S-corp will have to pay taxes because it owns stock. The S-corp’s annual income is taxed by having each shareholder include a portion of the S-corp’s revenue on their personal income tax return. Since the S-corp owns stock, some may think it should pay taxes. However, because treasury stock does not have voting or distribution rights and is not considered outstanding, the S-corp is not required to pay taxes due to any treasury stock it may hold.
John Cromwell specializes in financial, legal and small business issues. Cromwell holds a bachelor's and master's degree in accounting, as well as a Juris Doctor. He is currently a co-founder of two businesses.