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Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 29580
Experience:  Taxes, Immigration, Labor Relations
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An S corp has four shareholders. One shareholder purchased

Customer Question

An S corp has four shareholders. One shareholder purchased their stock in the company and paid for the stock with a promissory note, payable to the company; the note is secured by a pledge of the company stock. The shareholder is in default. The pledge agreement allows the secured party (the company) to vote the shares and receive all distributions allocable to those shares while the note is in default. If the company exercises that right and keeps distributions otherwise payable to this shareholder--does the company blow its S-corp election?
Submitted: 5 years ago.
Category: Tax
Expert:  Lev replied 5 years ago.

Hi and welcome to Just Answer!

Yes - that will violate the requirement to have only one class of shares.

The pledge agreement that allows the secured party (the company) to vote - creates a second class of shares and may not be done without approval of all shareholders - however with such approval - it will disqualify S-corporation - and it will be automatically treated as C-corporation.

 

Customer: replied 5 years ago.
Relist: Inaccurate answer.
Expert:  Lev replied 5 years ago.
Can you state what exactly is your concern?
Customer: replied 5 years ago.
Your explanation stated that, in essence, unequal voting rights among S corp shareholders blows the S corp election. It doesn't. Voting rights are irrelevant to S corp elections. Only the right to distributions/dividends must be equal. The question is whether assigning one's right to distributions to the company paying the distributions blows the election.