S Corporations and Stock Ownership Issues

The Small Business Job Protection Act of 1996 and its amendments in 1997 eased some of the stock restrictions surrounding S corporations. The amended law also added significant tax-saving provisions for S corporations and provided a number of important benefits for shareholders and employees.

Tax Benefits
Before the passage of the Small Business Job Protection Act, only individuals or other taxable entities could own stock in S corporations, and all corporate profits were subject to taxes. However, the amended law now allows a nontaxable Employee Stock Ownership Plan (ESOP) to hold stock in an S corporation, giving shareholders a way to defer some of their taxes.

Simply put, if you set up an ESOP for an S corporation and it owns 40 percent of your company’s stock, then 40 percent of your earnings are untaxed. Employees don't pay taxes on their ESOP holdings until they make a withdrawal from the plan, such as when they retire or leave the company.