Yes, an S corporation can legally have more than 100 shareholders by using a special tax rule called “family aggregation.” This rule allows a large family to be counted as a single shareholder. The primary conflict for growing family businesses is the direct clash between the company’s natural expansion across generations and the strict 100-shareholder limit imposed by Internal Revenue Code § 1361(b)(1)(A). Breaking this rule, even for one day, has an immediate and severe negative consequence: the automatic termination of the S corp’s favorable tax status, forcing it into a double-taxation system as a C corporation.
This structural challenge is a key reason why only about 12% of family businesses survive into the third generation, making long-term planning absolutely critical. Understanding how to navigate this rule is not just about taxes; it’s about preserving a family’s legacy.
Here is what you will learn by reading this article:
- ✅ How to legally count over 100 of your family members as just a single shareholder in the eyes of the IRS.
- 📜 The exact, step-by-step process for making the family aggregation election, which surprisingly does not involve filing a form with the IRS.
- 💔 How to shield your S Corp’s tax status from being destroyed by a divorce or after a death in the family.
- ❌ The critical but common mistakes that can accidentally terminate your S Corp status and the precise steps to avoid them.
- 🤔 When it might be time to let go of your S Corp status and what the best, most tax-efficient alternatives are for your growing family enterprise.
The 100-Shareholder Handcuffs: Why This IRS Rule Exists
An S corporation is a special type of company that gives its owners the best of both worlds. It provides the liability protection of a traditional corporation, meaning your personal assets are shielded from business debts. At the same time, it avoids the “double taxation” that hits regular C corporations, where the company pays tax on its profits, and then the owners pay tax again when those profits are distributed to them.
With an S corp, profits and losses “pass through” directly to the owners’ personal tax returns, so the money is only taxed once. This structure was created by Congress in 1958 specifically to help small and family-owned businesses grow without being crushed by taxes. To ensure this benefit was limited to smaller companies, the government created strict rules.
The most famous of these rules is found in Internal Revenue Code § 1361(b)(1)(A), which states that an S corp cannot have more than 100 shareholders. If a family business grows and gives shares to children, grandchildren, and their spouses, it can quickly approach this limit. The moment the company has 101 shareholders, its S corp status is automatically and immediately terminated.
The consequence is a forced conversion to a C corporation, subjecting the business to the double-taxation system it was created to avoid. Furthermore, the business is generally banned from re-electing S corp status for five years. This rigid rule creates a huge problem for successful multi-generational businesses that want to keep ownership within the family.
The Family Aggregation “Get Out of Jail Free” Card: Unpacking IRC § 1361(c)(1)
To solve this exact problem, Congress created a powerful exception called the family aggregation rule. This rule, found in IRC § 1361(c)(1), allows a business to treat all “members of a family” as a single shareholder for the purpose of the 100-shareholder count. This means a family business could have 150 family members who own stock, but for this specific IRS test, they all count as just one shareholder.
This is the key that unlocks an S corp’s ability to expand ownership across many generations without losing its valuable tax status. It is a deliberate workaround designed to support the long-term survival of family enterprises. Without it, many successful family companies would be forced to either sell or convert to a C corporation, fundamentally changing their financial structure.
Who Exactly Counts as “Family” in the Eyes of the IRS?
The IRS definition of “family” for this rule is both broad and very specific. It all starts with one person, called the common ancestor. This person is the starting point for the family tree, like the original founder of the company. The common ancestor does not need to be alive or even be a shareholder themselves.
Once you pick a common ancestor, the “family” includes:
- The common ancestor.
- All lineal descendants of the common ancestor (children, grandchildren, great-grandchildren, etc., including legally adopted children).
- The spouses and, importantly, the former spouses (ex-spouses) of the common ancestor and any of the lineal descendants.
There is one major limitation: the common ancestor cannot be more than six generations removed from the youngest family member who owns stock at the time the election is made. This prevents a company from picking an ancestor from the 1700s to group together hundreds of distantly related people. It keeps the definition of “family” within a reasonable, though still very large, scope.
The Biggest Misconception: This Rule Only Solves ONE Problem
Here is the most critical and often misunderstood part of the family aggregation rule. It helps you with the shareholder count only. It does absolutely nothing to change the other strict S corp eligibility rules.
Every single person within that aggregated family group who owns stock must independently be an eligible shareholder. This means each person must be a U.S. citizen or resident. They cannot be an ineligible entity like a partnership or another corporation, and any trust holding their shares must be a specially qualified S corp trust.
Think of it like getting into an exclusive club. The family aggregation rule gets your whole group through the front door by counting you as one person. However, the bouncer still checks every single person’s ID to make sure they meet the club’s individual requirements.
For example, imagine a family business has a valid aggregation election in place. A grandson who owns shares marries someone who is a non-resident alien. The moment his new spouse gains a community property interest in his stock, she becomes an ineligible shareholder, and the company’s S corp status is instantly terminated. The aggregation rule offers zero protection in this scenario because the problem is eligibility, not the number of shareholders.
The Secret Handshake: How to Actually Make the Family Aggregation Election
This is where most people get it wrong. You do not file a special form with the IRS to make the family aggregation election. There is no box to check on your tax return and no official document to mail to the government. The entire process is handled internally within the company.
The official guidance for this process comes from IRS Notice 2005-91. It states that the election is made when any shareholder who is a member of the family formally notifies the corporation of the family’s choice to be treated as a single shareholder. Because this is an internal process, the burden of proof falls entirely on the company to maintain perfect records.
If the IRS ever audits the company and questions its shareholder count, the company must be able to produce clear documentation proving that a valid election was made. Without this proof, the IRS could retroactively terminate the S corp status, leading to devastating back taxes and penalties. This makes the corporate minute book one of the most important tax documents a family business can have.
The Step-by-Step Notification Process Your Corporation Must Follow
Making a valid family aggregation election is a simple but formal four-step process. Following these steps precisely creates the legal proof needed to defend your S corp status during an audit.
Step 1: A Shareholder Writes a Formal Notification Any family member who owns shares can make the election. They must provide a written notice to the corporation that contains three specific pieces of information:
- The name of the family member making the election.
- The name of the “common ancestor” for the family group.
- The first tax year the election should be effective.
Step 2: The Corporation Officially Receives the Notice The notice should be formally delivered to the corporation’s officers (e.g., the President or Secretary). The receiving officer should date-stamp it and acknowledge its receipt. This marks the official start of the process.
Step 3: The Board of Directors Adopts a Resolution The corporation’s board of directors should hold a meeting to formally accept the shareholder’s election. They should pass a corporate resolution that acknowledges the notice, confirms the common ancestor, and directs the company’s officers to update the shareholder records to reflect the aggregation.
Step 4: Everything is Recorded in the Corporate Minute Book The original written notification from the shareholder and a certified copy of the board’s resolution must be permanently filed in the official corporate minute book. This book is the legal record of the company’s decisions and serves as the primary evidence that the election was properly made.
Real-World Family Dramas: How Aggregation Plays Out
Legal rules are best understood through real-life examples. These three scenarios show how the family aggregation rule works in situations that family businesses face every day.
Scenario 1: The Exploding Family Tree
A company, “Miller Machine Co.,” was founded by George Miller. As the business grew, shares were passed down to his children, grandchildren, and great-grandchildren. Through new births, marriages, and gifts, the number of people owning stock swelled to 125.
| Family Growth | IRS Shareholder Count |
| George’s 3 children and their spouses (6 people) | All part of the Miller family group |
| His 12 grandchildren and their spouses (22 people) | All part of the Miller family group |
| His 45 great-grandchildren (45 people) | All part of the Miller family group |
| 52 other descendants and spouses (52 people) | All part of the Miller family group |
| Total Individual Owners: 125 | Total Shareholders for IRS Test: 1 |
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By making a family aggregation election with George Miller as the common ancestor, the company can treat all 125 family members as a single shareholder. This keeps them safely under the 100-shareholder limit and preserves their S corp status.
Scenario 2: The Messy Divorce
Two of George Miller’s grandchildren, both shareholders, get divorced. As part of the settlement, their jointly owned stock is split between them. Without the family aggregation rule, this would be a problem. When they were married, they counted as one shareholder, but after the divorce, they would count as two, increasing the total shareholder count.
| Life Event | Impact on S Corp Status |
| Without Family Aggregation Election | The divorce increases the shareholder count by one. A series of divorces across the family could push the company over the 100-shareholder limit, terminating its S corp status. |
| With Family Aggregation Election | The divorce has zero impact on the shareholder count. The IRS rule specifically includes “former spouses” of lineal descendants in the family group, so both ex-spouses remain part of the single aggregated Miller family shareholder. |
This shows how the rule acts as a powerful shield, protecting the company’s tax status from the personal life events of its many owners.
Scenario 3: Planning for the Inevitable with Trusts
One of George’s children passes away, leaving her stock in a trust for her three children. The trust is designed to be flexible, allowing the trustee to distribute money as needed among the three beneficiaries. This type of trust is called an Electing Small Business Trust (ESBT), and it’s a popular tool for estate planning.
However, for the 100-shareholder test, the IRS counts each potential beneficiary of an ESBT as a separate shareholder. This single trust would normally add three shareholders to the company’s total count.
| Estate Planning Action | Shareholder Count Consequence |
| Step 1: Create an ESBT | The trust is an eligible S corp shareholder, so the S corp status is safe for now. |
| Step 2: Count the Beneficiaries | The three beneficiaries are counted as three separate shareholders under the ESBT rules. This increases the company’s total shareholder count by three. |
| Step 3: Apply Family Aggregation | Because the three beneficiaries are all descendants of the common ancestor (George Miller), they are immediately grouped back into the single Miller family shareholder. The net change to the shareholder count is zero. |
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This demonstrates a critical order of operations. The trust must first be an eligible type (an ESBT). Once that condition is met, the family aggregation rule neutralizes the negative impact on the shareholder count, allowing families to use flexible estate planning tools without fear of losing their S corp status.
S Corp Landmines: 5 Mistakes That Can Blow Up Your Family Business
Relying on the family aggregation rule magnifies the risk of an accidental S corp termination. A single misstep by any one of the dozens of family shareholders can have devastating consequences for everyone.
- Forgetting the Election is Internal. Many business owners assume the election is automatic or is made on an IRS form. They never formally notify the corporation or record it in the minutes. The consequence is that the election is legally invalid. If the company has more than 100 shareholders, its S corp status was terminated the moment it crossed the threshold, and the IRS can demand years of back taxes as a C corporation.
- Ignoring Individual Shareholder Eligibility. This is the most dangerous trap. A family gets so focused on the 100-shareholder count that they forget every owner must be eligible. The consequence of a shareholder gifting stock to a non-resident alien friend or putting shares in a standard, non-qualified trust is the immediate and automatic termination of the S corp election.
- Having a Weak or Nonexistent Shareholder Agreement. An S corp with many family owners absolutely must have a rock-solid shareholder agreement that strictly prohibits the transfer of stock to any ineligible person. The consequence of not having one is that a well-meaning but uninformed family member can unilaterally destroy the company’s tax status for everyone with a single prohibited gift.
- Accidentally Creating a Second Class of Stock. S corps are only allowed to have one class of stock, meaning all shares must have identical rights to distributions and liquidation proceeds. A poorly drafted buy-sell agreement or a side deal to give one family member a special payment can be interpreted by the IRS as creating a second class of stock. The consequence is instant termination of the S election.
- Poor Corporate Record-Keeping. The only proof that a valid family aggregation election was made is the corporate minute book. The consequence of failing to properly document the shareholder notification and the board’s resolution is having no defense during an IRS audit. The IRS will assume no election was made and can retroactively terminate the S status.
S Corp vs. C Corp: Is It Time to Make a Change?
As a family business grows, the rigid rules of an S corp can start to feel like a straitjacket. The family aggregation rule can delay the problem, but eventually, a company might need the greater flexibility of a traditional C corporation. Understanding the trade-offs is key to long-term planning.
| Feature | S Corporation | C Corporation |
| Taxation | Profits “pass through” to owners and are taxed once on personal returns. | Profits are taxed at the corporate level, then again as dividends when paid to owners (“double taxation”). |
| Shareholder Limit | Maximum of 100 (but family aggregation provides a workaround). | Unlimited shareholders. |
| Shareholder Type | Must be U.S. individuals, certain trusts, or estates. No corporations or partnerships allowed. | No restrictions. Shareholders can be anyone, including foreign investors or other companies. |
| Classes of Stock | Only one class of stock is allowed (though voting and non-voting shares are okay). | Can issue multiple classes of stock (e.g., preferred stock with special dividend rights). |
| Raising Capital | Difficult, due to limits on the number and type of shareholders. | Much easier. Can attract investment from venture capital funds and a wide range of investors. |
The Family Aggregation Playbook: Do’s and Don’ts
Navigating the family aggregation rule requires careful and consistent attention to detail.
Do’s
- DO create a formal, written shareholder agreement that restricts stock transfers to only eligible S corp shareholders. This is your number one defense.
- DO follow the internal election process precisely: get a written notice from a shareholder and record a board resolution in the minute book.
- DO map out your family tree and strategically choose the common ancestor who will group the largest number of current and future shareholders.
- DO conduct an annual review of your shareholder list to confirm that every single owner is still an eligible shareholder.
- DO educate all family shareholders, especially younger generations receiving stock for the first time, about the strict S corp rules.
Don’ts
- DON’T assume the family aggregation election is automatic or that it’s made on an IRS tax form. It is not.
- DON’T believe the rule solves all your problems. It only helps with the shareholder count, not with individual eligibility.
- DON’T allow any shareholder to place their stock into a trust without first having your corporate attorney confirm it is a qualified S corp trust (like a QSST or ESBT).
- DON’T forget about state laws. While S corp status is a federal tax election, some states have their own specific rules and filing requirements.
- DON’T create any special deals or payment arrangements for certain shareholders that could be seen as creating a second class of stock.
Weighing Your Options: Pros and Cons of Relying on Family Aggregation
Using the family aggregation rule is a powerful strategy, but it’s not without its downsides. It’s a trade-off between tax savings and increased complexity.
| Pros | Cons |
| Extends Tax Benefits: Allows the business to keep its valuable pass-through tax status for many more years, avoiding double taxation. | Increases Administrative Burden: Requires meticulous record-keeping and constant monitoring of a large and growing shareholder base. |
| Accommodates Family Growth: Enables ownership to be passed down through multiple generations without being forced to sell or convert the company. | Magnifies Compliance Risk: With more shareholders, the risk of one person making a mistake that terminates the S election for everyone increases dramatically. |
| Preserves Family Legacy: Helps keep the business in the family by allowing a broad base of descendants to participate in ownership. | Can Mask Deeper Issues: May delay necessary conversations about professionalizing management, creating liquidity for shareholders who want out, or establishing better governance. |
| Provides Flexibility in a Divorce: Protects the S corp status if shares are split in a divorce, as ex-spouses are included in the family group. | Can Complicate Family Disputes: Financial disagreements can become more complex and emotionally charged when dozens or hundreds of relatives are involved. |
| Simplifies Shareholder Counting: Reduces a potentially complex and ever-changing number of owners to a single, stable unit for compliance purposes. | Not a Permanent Solution: For very large or rapidly growing families, it may only be a temporary fix before a C corp conversion becomes inevitable. |
Frequently Asked Questions (FAQs)
Q1: Do we have to file a form with the IRS to make the family aggregation election? A: No. The election is made by a family member formally notifying the corporation, not by filing a form with the IRS. The corporation must document this notification in its official records.
Q2: Does the “common ancestor” have to be alive or own stock? A: No. The common ancestor does not need to be alive or have ever been a shareholder. They are simply the starting point for defining the family tree for the IRS.
Q3: What happens if a family member shareholder gets divorced? A: No, it does not increase the shareholder count if an election is in place. The IRS rule includes “former spouses” in the family group, so an ex-spouse who keeps stock is still counted within the single family shareholder.
Q4: Can our family S corp have 150 family members and one non-family employee as shareholders? A: Yes. The 150 family members would count as one shareholder under the aggregation rule, and the non-family employee would count as a second shareholder. The total count would be two, which is well below the 100 limit.
Q5: What happens if we accidentally go over the 100-shareholder limit? A: The S corp status terminates automatically. However, you can ask the IRS for “inadvertent termination relief.” If you can prove the mistake was unintentional and fix it quickly, the IRS may reinstate your S corp status.
Q6: Can a trust for multiple family members be part of the aggregation? A: Yes, but it’s a two-step process. The trust must first be an eligible type, like an ESBT. Then, its beneficiaries, who are counted as shareholders, can be grouped together under the family aggregation rule.
Q7: Is there a limit to how many family members can be grouped together? A: No. There is no legal limit on the number of family members that can be treated as one shareholder, as long as they all descend from the chosen common ancestor and meet the six-generation rule.
Q8: Does this rule apply to LLCs taxed as S corps? A: Yes. An LLC that has elected to be taxed as an S corporation must follow all the same S corp rules, including the 100-shareholder limit and the availability of the family aggregation election.