S Corp Operating Agreement Template

In plain language: Lists every shareholder, their legal name, share count, ownership percentage, and initial capital contribution — the foundational ownership record of the corporation.

Common mistake: Omitting the capital contribution amounts from the schedule. Without contribution records, disputes over basis calculations and disproportionate distribution claims become difficult to resolve.

In plain language: Obligates every shareholder to remain an eligible S-corp shareholder under IRS rules and requires immediate notice if their eligibility status changes — protecting the corporation's pass-through tax treatment.

Common mistake: Failing to define 'Eligible Shareholder' by reference to IRC §1361. Vague language leaves the obligation unenforceable and makes inadvertent termination harder to remediate with the IRS.

In plain language: Prohibits transfers of shares to ineligible persons and requires a selling shareholder to first offer their shares to the corporation and then to remaining shareholders before selling to any outside party.

Common mistake: Setting the ROFR price by formula reference without defining the valuation method. 'Fair market value' without a defined appraisal mechanism leads to disputes on every attempted transfer.

In plain language: Establishes each share's voting weight, the quorum required to hold a meeting, the vote thresholds for ordinary and extraordinary resolutions, and the procedure for calling and conducting meetings.

Common mistake: Treating all decisions as ordinary resolutions. Without supermajority requirements for major transactions — asset sales, new share issuances, or amendments to the agreement — minority shareholders have no protective threshold.

In plain language: Names the initial officers (at minimum a President and Secretary), defines their duties and signing authority, and establishes the process for appointing, removing, or replacing officers.

Common mistake: Setting no dollar threshold on officer signing authority. An unlimited authority clause allows an officer to bind the corporation to material contracts without shareholder knowledge or approval.

In plain language: Specifies that taxable income, losses, deductions, and credits are allocated to shareholders strictly in proportion to their pro rata share ownership — as required by S-corp rules, which prohibit special allocations.

Common mistake: Attempting to create preferred or special allocations of income to specific shareholders. S-corps are prohibited from making disproportionate allocations — doing so voids the S-election and triggers C-corp taxation.

In plain language: Defines when and how cash distributions are made to shareholders, typically including a mandatory tax distribution to cover each shareholder's personal tax liability on pass-through income.

Common mistake: No mandatory tax distribution clause. Shareholders owe personal income tax on S-corp income whether or not cash is distributed — without a tax distribution provision, minority shareholders can be left with a tax bill and no cash to pay it.

In plain language: Lists the events — death, disability, divorce, bankruptcy, or voluntary departure — that trigger an obligation for the corporation or remaining shareholders to purchase the affected shareholder's shares, and specifies how the purchase price is determined.

Common mistake: Listing triggering events without specifying a timeline for exercise or a valuation method. A buy-sell clause with no exercise deadline or pricing mechanism is unenforceable and converts every triggering event into litigation.

In plain language: Requires shareholder approval for the corporation to incur debt above a defined threshold or to issue new shares, preventing unilateral dilution or leverage that could impair existing shareholders.

Common mistake: Omitting this clause entirely and relying on the officer authority limit alone. Officers may legally bind the corporation to debt or equity transactions within their statutory authority unless the agreement expressly restricts them.

In plain language: States the jurisdiction whose law governs the agreement, requires any amendment to be in writing and signed by all shareholders, and confirms that this document supersedes all prior informal arrangements.

Common mistake: Allowing amendments by majority vote instead of requiring unanimous written consent. A majority-amendable agreement means minority shareholders can have their protections stripped without their approval.

Technically, most states do not legally require S-corporations to have a written operating agreement — corporate bylaws are the statutory baseline. However, an operating agreement (or a combined bylaws-and-shareholder agreement) is practically essential for any S-corp with more than one shareholder. Without one, share transfers are uncontrolled, buy-sell events become litigation, and there is no written record of the governance rules shareholders agreed to follow — courts apply default state law, which rarely matches what the parties intended.

Corporate bylaws cover the procedural mechanics of the corporation — board meetings, officer elections, record-keeping, and the like. An operating agreement (or shareholder agreement) goes deeper: it governs the economic relationship between shareholders, including transfer restrictions, buy-sell triggers, distribution policy, and S-election preservation. Many S-corps use a single integrated document that covers both. The critical S-corp protections — transfer restrictions and mandatory tax distributions — are almost always found in the operating or shareholder agreement, not in standard bylaws.

The S-election can be inadvertently terminated by a transfer of shares to an ineligible person, by exceeding 100 shareholders, or by issuing a second class of stock. A properly drafted operating agreement prevents all three: transfer restrictions block transfers to ineligible shareholders, a cap on total shareholders can be written in, and provisions confirming that all shares carry identical economic and voting rights prevent the creation of a de facto second class. The agreement also requires immediate notice if any shareholder loses eligible status, giving the corporation time to remedy the situation before the IRS terminates the election.

No. Under IRC §1361, an S-corporation may have only one class of stock — all outstanding shares must be identical in economic rights. Shares can differ in voting rights (voting vs. non-voting shares are permitted), but they cannot differ in liquidation or distribution preferences. Any agreement provision that creates a preferred distribution right or a different liquidation preference for any shareholder effectively creates a second class of stock and terminates the S-election. This is the single most common drafting error in S-corp governance documents.

The moment an ineligible person holds even one share, the S-election terminates automatically. The corporation becomes a C-corporation, subject to entity-level taxation on all income going forward, and re-electing S-status typically requires a five-year waiting period. The IRS does provide a relief procedure for inadvertent terminations under IRC §1362(f), but relief is not guaranteed, requires prompt action, and involves filing fees and potential penalties. Prevention through robust transfer restrictions is far less costly than remediation.

The IRS requires that shareholder-employees of an S-corp receive reasonable compensation — a salary comparable to what the market would pay for their work — before taking distributions. Paying nominal salary and large distributions to minimize payroll taxes is a well-known audit trigger. The operating agreement should define the distribution policy and require distributions to be strictly pro rata to ownership percentage. Including a mandatory tax distribution clause also demonstrates to the IRS that the corporation is administering distributions in a structured, good-faith manner.

Under IRC §1361, an S-corporation may not have more than 100 shareholders. However, members of the same family — defined broadly to include six generations descended from a common ancestor — may elect to be treated as a single shareholder for this purpose. The operating agreement should include a provision capping total shareholders at 100 (or fewer, for closely-held companies) and requiring shareholder approval before any new shares are issued.

For a two-shareholder S-corp with a simple ownership split and no outside investors, a high-quality template reviewed by a CPA for tax distribution mechanics is often sufficient. Engage a business attorney when there are more than three shareholders, when shareholders have materially different economic expectations, when equity is part of employee compensation, when the company is in a regulated industry, or when a buy-sell event is reasonably foreseeable in the near term. A 2–3 hour attorney review typically costs $600–$1,200 and is worthwhile for any S-corp with meaningful enterprise value.

The five most common termination triggers are: a transfer to an ineligible shareholder, exceeding 100 shareholders, having a non-individual entity as a shareholder (with limited exceptions for qualifying trusts), issuing a second class of stock, and failing to maintain US residency or citizenship for all shareholders. A well-drafted operating agreement addresses each one directly — transfer restrictions, shareholder caps, eligibility representations, single-class-of-stock confirmations, and ongoing notification obligations collectively cover all five risks.

No. An LLC that has elected S-corp tax treatment is still governed as an LLC under state law — it needs an LLC operating agreement, not a corporate operating agreement. The two documents have different statutory foundations: corporate law (with shareholders, directors, and officers) vs. LLC law (with members and managers). A corporate S-corp operating agreement used for an LLC would reference incorrect legal structures and could create governance ambiguity. Use an LLC operating agreement that incorporates S-election preservation provisions instead.