mediaphotos / Getty Images Shareholders profit when a company does well and lose money when a company does poorly. Learn more about how this process works, as well as other responsibilities stockholders have.
What Is a Shareholder or a Stockholder?
Shareholders and stockholders are the same things. Both words describe someone who owns shares of stock in a business. For the purposes of this article, we’ll use the term “shareholders.” Shareholders are individuals, companies, or trusts that own shares of a for-profit corporation. The individuals own a specific number of shares, which they each purchased at a specific price. The shareholders have invested their money to purchase these shares and they gain on their investment in two ways:
Through per-share dividends paid out the corporation’s profits By selling their shares at a profit
How Does Being a Shareholder Work?
Shareholders have different responsibilities and implications depending on the type of company and the number of shares you own.
Shareholders in Public vs. Closely Held Corporations
Most small corporations are closely held. That is, they have a few shareholders, most of whom know each other and in many cases, these shareholders are from the same family or have other business or personal relationships. Closely held companies are usually private.
A closely held corporation (sometimes called a “close corporation”) has a small number of shareholders and is not a public corporation. The number depends on the individual state’s business laws, but it’s usually defined as 35 shareholders.A publicly held corporation sells securities (stock) in a public offering and it discloses certain business and financial information regularly to the public. Once the company reaches a certain size, it must comply with certain public reporting requirements mandated by the Securities and Exchange Commission (SEC).
A public corporation can have millions of shareholders holding millions of shares. The individual shareholders have no direct involvement with the company, except to vote their shares on issues brought up at the annual meeting.
How Shareholder Income Is Taxed
Shareholders pay tax on their income in two ways:
They pay tax on dividends they receive based on their stock ownership. Dividends can be taxed as ordinary income or as capital gains, depending on the type of dividend. Ordinary dividends are paid out of earnings and profits and are taxed as ordinary income. Qualified dividends are ordinary dividends, but they are taxed at the capital gains rate, based on specific qualifications. They pay capital gains tax when they sell their shares at a profit. Capital gains taxes are based on how long the stock is owned (short-term vs. long-term capital gains).
A shareholder’s income from both dividends and sale of shares is included in their personal tax return.
Shareholders and the Annual Meeting
One of the most interesting things about being a shareholder of a corporation is that you have the right to attend the annual meeting. Even if you have only one share in a company, you can go to this meeting. If you have shares of stock, you may have received a proxy notification from the company. Since many shareholders are not able to attend the annual meeting, they can vote by proxy. Before the meeting, shareholders receive a proxy form or card to send back showing their vote on specific matters that come up in the annual meeting.
Shareholders and Double Taxes
For years there has been a discussion about the perceived unfairness of what is called “double taxation” on corporate shareholders. Briefly, double taxation, as imposed by the IRS, is first a tax on the earnings of the corporation, then a tax on those earnings distributed to shareholders as dividends. Corporations often elect S corporation status to avoid double taxation. An S corporation (subchapter S corporation) is a special kind of corporation that treats its shareholders differently from those of a C corporation for tax purposes. The S corp shareholders receive a pro-rata share of the company’s income, loss, deductions, and credits for the year, even if they haven’t been distributed to them. This is a type of pass-through income that is only taxed once. The shareholder receives a Schedule K-1 form showing the various forms of income or loss for the year, which is included in the shareholder’s personal tax return.
Shareholders in a Corporate Bankruptcy
The rights of the shareholders are subordinated (placed under) the rights of bond-holders so that shareholders lose the value of their shares if the corporation becomes bankrupt. The investors who take the least risk are paid first. Secured creditors come first, then unsecured creditors such as banks, suppliers, and bondholders. The owners are the last in line to be repaid if the company fails and they may not receive anything if there is no money left.
Different Types of Shareholders
Large corporations have different types of shareholders and types of stock that they own. Usually, a corporation will start out with common stock. Shareholders holding common stock have voting rights (one vote per share) at the annual meeting, they get dividends when the corporation pays them, and they can sell their shares for a profit (or a loss). Some companies also have preferred stock. Preferred shareholders receive dividends before common stockholders do, they have priority over common shareholders in bankruptcy. Preferred shareholders do not have voting rights.
