7780 / What is the requirement that an S corporation have only one class of stock and how is it met?

A corporation will be treated as having one class of stock if all of its outstanding shares confer identical rights to distribution and liquidation proceeds.¹ “Bona fide agreements to redeem or purchase stock at the time of death, disability or termination of employment” will be disregarded for purposes of the one-class rule unless a principal purpose of the arrangement is to circumvent the rule. Similarly, bona fide buy-sell agreements will be disregarded unless a principal purpose of the arrangement is to circumvent the one-class rule and they establish a purchase price that is not substantially above or below the fair market value of the stock. The IRS confirmed that this was the case, so that a buy-sell agreement could be disregarded, even when an equity compensation plan was involved that called for a forfeiture price for shares that could have been as low as $0.²

Agreements that provide for a purchase price or redemption of stock at book value or a price between book value and fair market value will not be considered to establish a price that is substantially above or below fair market value.³ Regulations provide that agreements triggered by divorce and forfeiture provisions that cause a share of stock to be substantially nonvested will be disregarded in determining whether a corporation’s shares confer identical rights to distribution and liquidation proceeds.⁴

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1. Treas. Reg. § 1.1361-1(l)(1).

2. Let. Rul. 201918013.