If you have an S corporation or are planning to set one up, you should know that the rules for S corp foreign shareholders have recently changed.
Prior to 2018, S corp foreign ownership laws did not allow non-resident aliens to be shareholders of S corporations in the U.S. The situation has evolved, and non-resident foreigners can now become S corporation shareholders via a legal entity known as an Electing Small Business Trust (ESBT).
By broadening the scope of eligible shareholders, the new rules open up fresh opportunities for small businesses seeking capital investment. Let us explore these in more depth.
Can a Non-US Citizen Own an S Corporation in Florida?
Until 2018, only U.S. citizens and permanent residents could own an S corporation in Florida. This excluded non-resident aliens or foreigners without permanent residency.
The Tax Cuts and Jobs Act of 2017 changed all that. The amended section 1361(c)(2)(B)(v) removes the prohibition against non-resident alien shareholders.
According to the new rules as set out in § 26 USC 1361, to qualify for S corp status, a corporation must:
- Be a domestic corporation
- Issue only one class of stock
- Have a maximum of 100 shareholders
- Have permissible shareholders only, i.e., individuals and some types of estates and trusts, including Electing Small Business Trusts
- Not have shareholders that are partnerships, corporations, or non-resident aliens
- Not be an ineligible corporation, i.e., certain financial institutions, domestic international sales corporations, and insurance companies
It is important to note that non-resident aliens still cannot be direct S corp shareholders. However, under the amended rules, they can now be indirect shareholders by becoming beneficiaries of an Electing Small Business Trust or ESBT.
The trustee can make the ESBT election within two months and 15 days from when the trust received S corp stock. The filing is made with the service center where the corporation files its income tax return.
You may also specify the ESBT status in your Florida corporation bylaws, but this is not a mandatory requirement.
Are S Corp Foreign Shareholders Allowed in Florida?
S corp foreign shareholders are allowed in Florida. However, the rules differ for resident and non-resident aliens.
Resident aliens, i.e., non-U.S. nationals who hold a green card or meet the substantial presence test, can become direct shareholders of S corporations, much like U.S. nationals.
Non-resident aliens, i.e., foreigners who do not have a green card or meet the substantial presence test, cannot be direct S corp owners. However, they can be indirect shareholders by becoming beneficiaries of a legal entity known as an Elected Small Business Trust or ESBT.
When & Why Should You Be Interested in a Foreign Shareholder S Corporation?
An S corporation is a corporation or a limited liability company (LLC) that opts to be taxed under Subchapter S of the Internal Revenue Code.
To be treated as an S corporation for tax purposes, you need to set up a corporation or an LLC first and then submit Form 2553 Election by a Small Business Corporation signed by all shareholders to the IRS.
The federal government introduced S corporation status back in 1958 to extend some of the legal and tax benefits of corporations to families and small businesses, making it easier to scale, avoid legal liability, and keep tax rates as low as possible. Thanks to the amendments introduced by the Tax Cuts and Jobs Act of 2017, these advantages can now be enjoyed by non-resident aliens as well. These include:
Pass-Through Taxation
Like domestic and non US resident LLC businesses, S corporations enjoy pass-through taxation. All income, losses, deductions, and credits generated by the corporation are divided, “passed through” to the shareholders, and taxed as personal rather than corporate income.
The corporation itself only pays taxes on passive income and capital gains. In fact, S corporations in Florida do not even have to file an income tax return unless they have experienced built-in gains, last-in-first-out (LIFO) recapture, or excess net passive income.
While there are similarities to LLC and S corp status, they are not the same thing. You should carefully research the benefits of S corp vs LLC before committing to a business structure for your business.
Unlike LLC and S corp income, the income of C corporations is taxed as corporate income at higher rates. This is one of the downsides of C corp foreign ownership. C corporations must also take extra measures to prevent double taxation when passing profits onto owners.
Lower Self-Employment Tax Rates
S corporations enjoy lower self-employment tax rates than partnerships and C corporations. S corp shareholders only pay self-employment tax on their salaries and not on business profits allocated to them, which are tax-free or taxed at lower rates than income tax. You can choose how to distribute business profit to benefit from lower self-employment tax rates and tax-deductible losses.
Limited Liability Protection
S corporations are separate legal entities. Shareholders are not responsible for the actions, debts, and liabilities of the corporation unless they commit a criminal offense or fail to apply corporate rules and regulations. If the corporation goes bankrupt, the personal assets of its owners remain safe. For more details, read our post on piercing the corporate veil in Florida.
Perpetual Existence
S corporations can operate indefinitely, even if their owners sell their shares or die suddenly. In contrast, partnerships and sole proprietorships are tied to specific individuals.
Easy Ownership Transfer
Ownership of S corporations can be transferred easily with no major tax consequences or onerous compliance and accounting requirements.
Separation Between Management and Ownership
An S corporation can have separate managers and owners. This is not the case with other business entities such as partnerships, sole proprietorships, and LLCs.
More Credibility
Due to the built-in liability protections, S corporations generally have more credibility than partnerships and sole proprietorships, making it easier to attract investors and sell shares.
Who Can Qualify as an S Corp Foreign Shareholder?
The eligibility requirements for S corp foreign shareholders differ depending on whether they are resident or non-resident aliens.
Rules for an S Corporation Non-Resident Alien
The U.S. Tax Code does not allow non-resident foreigners to have direct ownership in S corporations. This is because non-resident aliens are not subject to U.S. income tax. Direct ownership in S corporations would essentially enable them to hold investments in the U.S. tax-free.
However, the Tax Cuts and Jobs Act of 2017 now permits non-resident aliens to own shares in S corporations indirectly through business entities known as Electing Small Business Trusts or ESBTs. The trust is treated as an S corp shareholder and pays federal income tax at the trust level, which means that trust beneficiaries have their income taxed before it is allocated to them personally.
Rules for an S Corp Resident Alien
Unlike non-resident foreigners, resident aliens can hold direct ownership in S corporations. A resident alien is a non-U.S. citizen who either:
- Has a green card
- Meets the substantial presence test for each calendar year
Who Cannot Be a Shareholder in an S Corporation?
Partnerships, corporations, and non-resident aliens cannot be direct shareholders of an S corporation. However, non-resident aliens can be indirect shareholders in S corporations by becoming trustees of a qualifying Electing Small Business Trust (ESBT).
Final Points on S Corp Foreign Ownership & Shareholders
To sum it up, following the changes introduced by the Tax Cuts and Jobs Act of 2017, an S corporation foreign shareholder can either be:
- A resident alien (subject to the same rules as U.S. citizens)
- A non-resident alien trustee of an Electing Small Business Trust (ESBT)
Need Help with S Corporation Foreign Shareholder Law?
The new rules for S corp foreign shareholders open up many opportunities and can help small and family-owned businesses raise capital from a wider pool of investors than ever before. You could even consider joint ventures with foreign business partners that were previously impossible.
That said, if you are interested in setting up an Electing Small Business Trust, keep in mind that the process is complicated. Details are important. A single mistake could compromise a non-resident alien’s shareholder status and jeopardize the entity’s S corp status altogether.
To best protect your interests, you should talk to a specialist corporate and tax attorney. Contact the Cueto Law Group today to make the most of the new S corp foreign shareholder provisions.
FAQs
Do S Corp Shareholders Have to Be U.S. Citizens?
Direct S corp shareholders must be U.S. citizens or resident aliens who either hold a green card or meet the substantial presence test. Non-resident aliens cannot be direct S corp shareholders but can have indirect ownership by becoming trustees of an Elected Small Business Trust (ESBT).
Can an S Corp Have Foreign Employees?
An S corporation can have shareholder-employees working outside the U.S. They can exclude around $100,000 earned outside the U.S. as long as they are bona fide residents of another country year-round or are physically present in another country for 330 days in a twelve-month period or more.
Am I Considered Self-Employed If I Own an S Corp?
Owners of S corporations are not considered self-employed. They only pay self-employment tax on their salaries, not on business profits distributed to them. By setting up an S corporation, you can choose how much of your income to classify as a salary and distributions to benefit from lower self-employment tax rates.
