Can a Foreign Person Be a Shareholder of an S-Corporation?

One of the most asked questions by foreign individuals planning to conduct business in the U.S. is whether a foreigner can be a shareholder of an S-corporation. Below are some basic concepts aimed at helping one to understand the rules applicable to different classes of alien individuals as governed by Internal Revenue Code 871. This information will be of relevance to a foreign person or someone doing business with a foreign partner.

First, there are S-corporation status qualifications. To qualify for S-corporation status, the corporation must meet the following requirements:

• Be a domestic corporation

• Have only allowable shareholders including individuals, certain trusts, and estates and may not include partnerships, corporations or NONRESIDENT alien shareholders

• Have no more than 100 shareholders

• Have only one class of stock

• Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).

Noted above, NONRESIDENT ALIENS appear to be ineligible shareholders for purposes of S-corporation status qualification. However, the question arises as to whether any particular legal immigration status (e.g. holding a certain visa) has any impact on whether a nonresident alien can be an S-corporation shareholder. The short answer to that is "no". 

A deeper examination of how nonresident aliens are treated for U.S. income tax purposes will provide further explanation.

For purposes of income tax, alien individuals are generally divided into two categories: RESIDENT ALIENS and NONRESIDENT ALIENS. Therefore, the manner by which aliens are taxed by the United States significantly depends on the residency status of such aliens. The residency rules for tax purposes can be found in Internal Revenue Code 7701(b). Although the tax residency rules are based on the immigration laws concerning immigrants and nonimmigrants, the rules define residency for tax purposes in a way that is different from the immigration laws. Under the residency rules of the Internal Revenue Code, any alien who is not a RESIDENT ALIEN is a NONRESIDENT ALIEN. In other words, any alien under the immigration law (even an undocumented alien) who passes the substantial presence test (described below) will be treated as a RESIDENT ALIEN for tax purposes. 

Residency Test under U.S. Tax Law

If questions should arise as to what residency test and/or tax rules are applicable to resident and nonresident aliens, they can be summarized as follows:

In general, RESIDENT ALIENS are taxed in the same manner as U.S. citizens, that is a resident alien is taxed on income derived from all sources, including sources outside of the United States, and NONRESIDENT ALIENS are taxed only on certain income from sources within the United States and on the income described in IRC 864( c)(4) from sources outside of the United States which is effectively connected for the taxable year with the conduct of a trade or business in the United States. 

An important aspect is that an alien is treated as a RESIDENT ALIEN in one of three ways:

1. By being admitted to the United States as, or changing status to, a Lawful Permanent Resident under the immigration laws (the Green Card Test);

2. By passing the Substantial Presence Test (which is a numerical formula which measures days of presence in the United States); or

3. By making "First-Year Choice" (a numerical formula under which an alien may pass the Substantial Presence Test one year earlier than under the normal rules). 

Based on the above analysis, a foreign person (alien) can be an eligible shareholder of an S-corporation. As long as the foreign individual meets the definition of a RESIDENT ALIEN for U.S. income tax purposes, he or she will be considered an eligible shareholder for purposes of S-corporation status qualification. The determination as to whether a foreign person meets the definition of a RESIDENT ALIEN for income tax purposes has to be made for each taxable year. 

Additionally, nonresident aliens are not subject to self-employment tax. However, once a nonresident alien becomes a RESIDENT ALIEN under the U.S. tax law residency test, he or she will be subject to self-employment tax under the same rules as U.S. citizens.

If at any point of time a shareholder becomes ineligible shareholder for purposes of S-corporation qualification, the entity will lose its S-corporation status. When an entity loses its S- corporation status, the entity becomes treated for U.S. federal tax purposes as a C-corporation. In general, the S-corporation's tax year is deemed to end the day before the failure to adhere occurs and the C-corporation's tax year begins on the day of the failure to adhere. If an S-corporation election is terminated, a five- year waiting period applies during which the corporation cannot re-elect S-corporation status without IRS consent (IRC 1362(g)).

Volha Little, CPA is a partner at Little & Ponce CPAs, LLP a professional services firm that provides comprehensive tax, accounting, and consulting services to private and public companies, individuals, and business owners. For more information on any of the provisions discussed in this article or for insight on tax planning strategies that may help you reduce your tax exposure, contact us at [mailto:cpas@littleponce.com]cpas@littleponce.com-OR

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