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Why Issuing S-Corp Shares to Resident Aliens Is A Risky Bet

October 23, 2015

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Read our in depth research on issuing shares of a S-corporation to aliens here.

Whenever a S-corporation issues shares to a resident alien, the other shareholders of the corporation are placing a bet on the foreigner’s desire (and ability) to remain in the US.

Although the tax code permits certain foreigners to be shareholders of S-corporations, we do not casually suggest it, because a foreigner who does not stay in the country long enough during a particular year can inadvertently cause the corporation to lose its status as a S-corporation.  This can cause disastrous and unfair tax consequences to the other S-corporation shareholders.

In general, the requirements for being a “small business corporation” (and eligible for S-election) can be controlled by the corporation’s shareholders. For example, the corporation can ensure that it is not creating more than one class of stock or selling its stock to more than 100 shareholders or to partnerships or other corporations. But if an existing shareholder fails to maintain his status as a “resident alien” for unforeseen reasons, there is little the other shareholders can do to control that eventuality.

The tax code provides that a S-Corporation must not have a nonresident alien as a shareholder. Having a particular visa has no impact.  Only a green card or meeting the IRS’ “substantial presence test” enables an alien to be eligible to be an S Corporation shareholder.

An alien can meet the substantial presence test by being physically present in the United States for at least 31 days during that calendar year and for at least 183 days during a three-year period that includes the calendar year.

Even if physically present in the United States, certain “exempt individuals” are not treated as being present in the United States. Exempt individuals include certain persons temporarily present in the United States, including a teacher or trainee, a student, and a person related to a foreign government (such as a diplomat). As such, a corporation wishing to maintain its status as an S corporation should be especially careful about selling its shares to a foreigner who would qualify as an exempt individual under the Internal Revenue Code. In other words, certain types of visas an hinder the ability of a S-corporation to maintain its S election.

To be clear, it is not illegal for a nonresident alien to purchase stock in an S corporation. But if a nonresident alien buys stock in an S corporation, or if an alien shareholder does not have a green card and fails to meet the substantial presence test in a particular year, then the corporation will lose its tax status as an S corporation. So, for example, if an alien shareholder is unable to travel to, and be physically present in, the United States for at least 31 days in the calendar year due to an unexpected illness, then the corporation can lose its S corporation status, and all of the shareholders will suffer the tax consequences. For that reason, an S corporation must be very cautious about having foreigners as shareholders (and the risk is obviously multiplied the more foreign shareholders an S corporation has).

Read more about issuing shares of a S-corporation to aliens by clicking here.

Our attorneys are admitted to practice law in California, New York, and Texas.
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