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Before the shares move, business owners should confirm the practical issues that can affect taxes, control, eligibility, and company records.
You may be trying to figure out how to transfer S corp stock to a family member because your child is joining the family business, your spouse now needs to appear in the ownership records, or succession planning has moved from “someday” to an actual decision.
That decision can affect taxes, control of the company, voting rights, and the long-term plan for the S corporation. It can also affect S corp eligibility because stock transfers must comply with IRS shareholder and ownership rules.
This article explains what business owners should review before transferring S corp shares to a family member, including fair market value, gift tax, capital gains tax, carryover basis, step-up in basis, shareholder eligibility, and company records.
An S Corp or an S Corporation is a business structure that is a pass-through entity for tax purposes. This means the business does not pay taxes on its profits. Instead, profits and losses are passed through to the shareholders, who report them on their individual tax returns.
This structure can offer several tax benefits that make these entities attractive to entrepreneurs. For one, it avoids double taxation, where income is taxed at both the corporate and personal levels. Finally, S-Corp members can split their income between salary and dividends — the latter is exempt from employment taxes.
Before you focus on the tax implications, identify the type of transfer you are making. A gift of S corp shares is different from a sale, a spouse transfer, a trust transfer, or a transfer after the owner's death.
A gift happens when you transfer S corp stock to a family member without receiving full fair market value in return. This method often comes up when a parent wants to move part of the family business to a child during life.
A sale happens when a family member buys S corp shares from the current owner. The buyer may pay cash at closing, make installment payments, or use seller financing if the seller agrees to be paid over time.
A spouse transfer may happen because a spouse is joining the business, the family's estate plan needs to match the ownership records, or marital planning requires a change in how the shares are held.
After the owner's death, S corp shares may pass through an estate, a will, a trust, or a buy-sell agreement. This type of transfer can raise questions about who has authority to act for the shares and who should appear as the new shareholder.
A trust transfer may be part of family succession planning, but it needs careful review. A trust is not the same as an individual family member, and not every trust can hold S corp shares.
The transfer method changes the legal and tax analysis, but you should review these issues before any S corp shares move.
Fair market value: The company may need a valuation or other support for the fair market value of the S corp shares. Value matters in a gift, sale, or other transfer because it affects tax reporting and helps explain the transaction later.
Tax treatment: A gift may raise gift tax reporting. A sale may raise capital gains tax. A transfer after the owner's death may raise step-up in basis questions. The transfer method determines which tax issues need closer review.
Shareholder eligibility: The recipient must be eligible to own S corp stock. This needs closer review when the recipient is a trust, a non-U.S. person, another business entity, or an arrangement that may not fit S corporation rules.
Buy-sell agreement and transfer restrictions: The company's buy-sell agreement, shareholder agreement, bylaws, or prior consents may restrict the transfer. Some transfers require notice, approval, or a right of first refusal before shares move.
Company records and voting rights: The stock ledger, transfer documents, and ownership records should match the transaction. If voting rights or distribution rights change, the company should address that before the transfer is completed.
The tax implications for S-Corp stock transferred to heirs depend on whether the assets are gifted during your lifetime or bequeathed after death. Below is the taxation structure for gifted S-corp shares:
Upon sale, the difference between these assets' price and carryover basis (for gifted assets) is subject to capital gains tax. Here’s an example:
Suppose you bought S-corp shares at $100,000. Over time, they appreciated to $400,000. You later gift these shares to your children, who decide to sell them. The difference between the sale and the original price, $300,000, is subject to capital gains tax. For shares held for one year or less, the difference will be subject to short-term capital gains, typically at ordinary income rates. Shares held for more than one year are subject to long-term capital gain, which is generally more favorable than income tax rates.
As such, it is important to consult a business lawyer to manage the timing of a sale to qualify for long-term capital gains, reducing tax liabilities.
On the other hand, if the shares pass to your heirs after death, taxation works differently. Specifically, the step-up in basis adjustment applies, which is the readjustment of an asset's value for tax purposes upon inheritance.
Therefore, the value of these stocks is stepped up to the fair market value at the time of the previous shareholder's death. Should the new owner decide to sell these shares later, the adjustment will affect their capital gains liabilities.
For example, if the previous shareholder purchased the S-Corp shares for $100,000, which increased to $400,000 by their death, the inheritor's basis is readjusted to the fair market value of the shares at the time of the owner's death, i.e., $400,000. If the inheritor sells these assets at this price, they won't incur capital gains tax because the sales price equals the stepped-up basis.
However, should the inheritor bequeath the shares to their heirs, the step-up in basis will not apply. The adjustment only applies upon the death of the holder of the original shares.
When transferring your S-Corp stock to family members, be aware of the strict eligibility requirements for S-Corp ownership. The IRS stipulates that individual owners must be US citizens or permanent residents. Transferring shares to ineligible parties can jeopardize the business's eligibility for special S-Corp tax considerations.
It's also crucial to remember that S-Corporations are limited to a maximum of 100 shareholders. This is particularly important for large families or when multiple generations are involved. Additionally, be aware of gift tax limitations that affect the total and annual value of assets you can gift.
If you are preparing to transfer ownership of your New Jersey or New York family business, you first need to understand what approvals, company records, contract restrictions, filings, and next steps should be reviewed before the transfer moves forward.
Wilkinson Law LLC offers an Family Business Ownership Transfer assessment fixed fee service for business owners who want a focused legal review before committing to the full transfer process. You receive a concise written action plan outlining the required documents, approvals, filings if any, proposed timeline, and anticipated cost for implementation.
To see whether this fixed-scope assessment is right for your business, review our Assess Family Business Ownership Transfer for New Jersey and New York Companies fixed fee service.
This concludes the fifth publication in our comprehensive business succession planning series. By now, you should have a clear understanding of the tax issues involved in transferring S-Corp shares to family members. We invite you to join us for another insightful piece focusing on tax considerations when transferring partnership interests to family members.
Are you wondering about any of the issues mentioned above? Please email us at info@wilkinsonlawllc.com or call (732) 410-7595 for assistance.
At Wilkinson Law, we give business owners the clarity they need to fund, grow, protect, and sell their businesses. We are trustworthy business advisors keeping your business on TRACK: Trustworthy. Reliable. Available. Caring. Knowledgeable.®
Yes. S corp stock can generally be transferred to a family member, but the transfer should be reviewed before the shares move. The company’s bylaws, shareholder agreement, buy-sell agreement, and prior consents may limit or condition the transfer. The company should also confirm that the recipient is eligible to own S corp stock and that the transfer does not create tax, control, voting, or recordkeeping problems.
Yes. A shareholder may gift S corporation stock to a family member, but the gift should be supported by fair market value and properly documented. The transfer may raise gift tax reporting issues, and the recipient may take the donor’s carryover basis in the shares. Before gifting S corp stock, business owners should also confirm that the recipient is an eligible S corp shareholder and that the company’s governing documents allow the transfer.
Sometimes a stock transfer may not create immediate income tax, but that does not mean the transfer has no tax consequences. A gift may raise gift tax reporting issues. A sale may create capital gains tax. A transfer after death may involve step-up in basis rules. The tax result depends on how the shares are transferred, the value of the stock, the owner’s basis, and whether the transfer happens during life or after death.
After an S corp stock transfer, the company should update its stock ledger, ownership records, transfer documents, and any required approvals or consents. If the transfer changes voting rights, distribution rights, or management influence, those changes should also be reflected in the company’s records. Clear records help show who owns the shares, when the transfer happened, and whether the company followed its governing documents.
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