Key Takeaways

  • An LLC generally cannot own an S Corp unless it qualifies as a disregarded entity.
  • S Corps have strict IRS rules on eligible shareholders—only U.S. individuals and certain trusts are allowed.
  • Single-member LLCs may own S Corps if they are treated as disregarded entities for tax purposes.
  • There are alternative strategies such as forming a holding company or utilizing QSubs.
  • The ownership restrictions are in place to preserve the tax advantages of S Corporations and prevent tax evasion by ineligible entities.An LLC, or limited liability company, is a business which files state taxes under a certain set of regulations that allows for decreased paperwork, pass-through income, and a limitation on the owners' personal liability equal to the amount invested in the company. 

S Corporations, on the other hand, are a federal tax filing that puts the company taking advantage under the jurisdiction of Subchapter S of Chapter One of the tax code. This provides advantages similar to an LLC, only on federal taxes, and with stricter requirements. Although both kinds of filings can help a business, they can also cause confusion over issues such as what kinds of companies they are allowed to own.

S Corporations and LLCs

First, you need to understand what characterizes an LLC and an S Corporation as a taxable entity. An LLC is a company that files in such a way that, for state tax purposes, its income is treated as the personal income of the owner or owners and subject to the self-employment tax. It also receives certain benefits regarding financial responsibility for the company's actions and cuts down on paperwork. This can help reduce or eliminate double taxation on earnings from ownership stakes in a company. An LLC can file federally as a privately-held company or as a corporation because the IRS does not recognize the LLC as a kind of tax status.

S Corporations give very similar benefits, but on the federal level rather than the local. An S Corporation also counts income from the company as “pass-through,” or self-employed income rather than corporate. This is especially useful when it comes to paying payroll taxes, which would then only be counted against wages rather than the total profit. In exchange for this preferred filing status, the company agrees to several restrictions on its structure and practices:

  • All shareholders or partners need to be US residents, whether permanent residents or US citizens.
  • The company is restricted to 100 shareholders, though family members and spouses all count as a single person for this calculation.
  • The company is not allowed to make use of different stock classes, though it is allowed to have both voting and non-voting stock.
  • Only individuals are allowed to be shareholders of an S Corporation, not investment firms or corporations or similar instruments.
  • Certain classes of business are expressly forbidden from using Subchapter S. This includes kinds of insurance agencies, financial institutions, and international companies.

Differences in Ownership Structures and Flexibility

While LLCs and S Corporations offer similar liability protections and pass-through taxation, they differ significantly in terms of ownership structure and compliance obligations.

  • Ownership Flexibility: LLCs can have unlimited members, including individuals, corporations, foreign entities, and even other LLCs. S Corps, by contrast, are limited to 100 shareholders and cannot be owned by corporations, partnerships, or non-resident aliens.
  • Management Style: LLCs allow for more flexible management structures—members can manage the LLC themselves or appoint managers. In contrast, S Corps are required to have a board of directors and corporate officers, maintaining a more rigid corporate governance format.
  • Profit Distribution: LLCs can allocate profits and losses disproportionately, based on the operating agreement. S Corps must allocate profits and losses strictly in proportion to share ownership.

This difference plays a critical role in determining whether an LLC can own an S Corp. Because S Corp ownership is restricted to certain types of shareholders, LLCs must meet very narrow criteria—typically being a single-member LLC taxed as a disregarded entity—to qualify.

Restrictions

When it comes to LLCs owning shares in S Corporations, the main problem they encounter is the fourth requirement. An LLC is not an individual; it is a company. Since it does not meet the shareholder requirements, it can't be a shareholder without canceling the S election of the S Corporation in the process

For LLCs owned by multiple people, that is the end of it. However, sometimes an LLC is owned by exactly one private individual who has organized his business that way for a tax advantage. These LLCs are called disregarded entities by the IRS, and, in accordance with IRS rulings, are allowed to own a stake in an S Corporation. This is subject to the same restrictions as all the other owners of an S Corporation. Moreover, the LLC cannot file federally as a corporation, as a corporation is not allowed to own part of an S Corporation, even if the only shareholder is a single individual.

When an LLC Can Own an S Corporation

Although the IRS generally prohibits corporations, partnerships, and LLCs from owning shares in an S Corp, an important exception exists for single-member LLCs. If a single-member LLC is classified as a disregarded entity for federal tax purposes and its sole owner is an eligible S Corp shareholder (i.e., a U.S. citizen or resident), then it may own an S Corporation.

However, the IRS considers multi-member LLCs to be partnerships, which disqualifies them from owning S Corp stock. Also, if an LLC has elected to be taxed as a corporation, it is disqualified regardless of how many members it has.

Here are the core requirements that must be met:

  • The LLC must be a single-member LLC.
  • It must be treated as a disregarded entity for tax purposes.
  • The single member must be a qualified S Corp shareholder under IRS rules.

Failing to meet these conditions can result in the automatic termination of the S Corporation's status.

Why?

Though the strict IRS rulings may seem like a hassle to small businesses and their owners, there are very good reasons for their requirements. Since S Corporations allow income to pass through to a small number of individuals as personal income, there would exist the possibility of foreign nationals and the like using an S Corporation as a way to funnel money to a party not required to file US taxes, thus denying all taxation on this income. Since the S Corporation rules are designed to encourage certain kinds of American businesses by making them more competitive though beneficial tax breaks, this would completely subvert the purpose of the rules in the first place.

Alternatives to Direct LLC Ownership of an S Corp

For business owners seeking the benefits of both LLC and S Corp structures, there are a few alternative strategies to consider:

  • Parent-Subsidiary Setup: An individual can own both a single-member LLC and an S Corp separately, using each for different business purposes while maintaining compliance.
  • Holding Company Structure: A qualified individual may create a holding company to oversee both entities. For instance, the individual owns the S Corp directly while using the LLC for property management, intellectual property, or liability insulation.
  • Qualified Subchapter S Subsidiary (QSub): An S Corp can own a wholly-owned subsidiary that elects QSub status. This can provide some structural flexibility for internal divisions of the business while maintaining S Corp status.
  • Trust Ownership: Certain types of trusts (e.g., grantor trusts, qualified subchapter S trusts (QSSTs)) may be permitted to hold S Corp shares and offer another route to ownership structuring.

Each approach has distinct tax and legal implications, and the optimal structure will vary depending on business goals, liabilities, and long-term plans.

Frequently Asked Questions

  1. Can a multi-member LLC own an S Corp?
    No. Multi-member LLCs are treated as partnerships for federal tax purposes, which disqualifies them from owning shares in an S Corp.
  2. What happens if an ineligible entity owns S Corp stock?
    The S Corporation status is automatically terminated, and the entity becomes a C Corporation, subject to double taxation.
  3. Can a single-member LLC taxed as a corporation own an S Corp?
    No. Even a single-member LLC cannot own an S Corp if it elects to be taxed as a corporation.
  4. Are there alternatives if an LLC can't own an S Corp?
    Yes. Individuals can use strategies like owning both entities directly, forming holding companies, or using QSubs to structure operations effectively.
  5. Why does the IRS restrict S Corp ownership?
    The restrictions help maintain the pass-through tax structure intended for small U.S.-based businesses and prevent misuse by foreign or corporate investors.

If you need help with figuring out if your LLC is legally allowed to own a stake in an S Corporation, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.”