Can an S Corp Own an LLC: Everything You Need to Know
Are you wondering, can an S corp own an LLC? An S Corp can own an LLC. LLC have owners (members) that can be individuals or other business entities.5 min read
Updated May 4, 2022:
Are you wondering, can an S corp own an LLC? An S corp can own an LLC. Limited liability companies (LLCs) have owners (members) that can be individuals or other business entities. An S corporation (S corp) is a business entity; therefore, it can be a member, or owner, of an LLC.
What Is an S Corp?
S corps are corporations that have filed with the state but have elected a special tax status with the IRS (Internal Revenue Service). S corps elect to be viewed as a sole proprietorship or disregarded entity when it comes to taxation but remain like corporations in every other sense.
Sole proprietorships and disregarded entities are classified as pass-through entities because the company is not taxed on its profits. Instead, its members or shareholders have the profits passed through to them. The company profits are then taxed only once, on the shareholders' personal income tax returns.
Can an S Corp Own an LLC?
Corporations distribute profits to their investors, those who have an ownership percentage in the company, through shares. Corporate business structures are appealing because they allow the company to sell ownership percentages, or stocks, to anyone in the world.
LLCs can buy into any other business entity, because they have the legal ability to own property and manage assets. An LLC can act as an investor in a corporation just like an individual would, but S corporations can only be owned by actual individuals.
Even though an S corp cannot be owned by an LLC, an S corp can own an LLC. In the terms of an LLC, an S corp can have membership in an LLC.
The IRS approves disregarded entity status to a business with the understanding that the business will make sure that profits are tracked and treated as individual income on the personal tax return of one or several owners, shareholders, or members in the company.
Income that is given to an individual or business entity that is not required to file an income tax return is lost in the eyes of the IRS.
Because of this possibility of lost income, rules and regulations are enforced by the IRS to prevent companies from skirting around paying taxes on business income.
In order for a corporation to file as an S corp (and therefore gain disregarded entity status) the following rules must apply:
- The company shareholders must be individuals, tax-exempt organizations, trusts, or estates.
- Individual shareholders must be citizens and residents of the United States.
- Shareholders cannot be any business entities (LLCs, corporations, etc.).
If another disregarded entity, like an LLC, was an owner of an S corp, income taxes would be missed because the S corp income isn't taxed and is passed to its shareholders. LLC incomes are also not taxed, so the profits would go untaxed.
If only individuals are shareholders in an S corp, all profits passed to individuals are included on their personal income tax returns.
If an S corp tries to pass through any business profits to a shareholder that doesn't meet the requirements (like an LLC or a nonresident alien) the company status is automatically changed back to a corporation and taxed as such from then on.
S Corp Versus LLC
There are some similarities between S corps and LLCs as both are regarded as pass-through entities by the IRS, and they both protect their members and shareholders from liabilities.
LLCs, however, have a simpler startup than S corps, and they have easier operation requirements and administrative duties. S corps require yearly reports and documentation with the state. LLCs have more freedom when it comes to membership with no restrictions on the amount of members or their status of citizenship.
LLCs are also free to create a unique plan for distributing company profits that isn't required to correlate with ownership percentages or capital contributions. An S corp must distribute shares according to each shareholder's initial investment amount.
An LLC is taxed under self-employment tax, like a partnership or sole proprietorship would be unless it files to be taxed as a corporation.
Even though S corps have more restrictions than LLCs, they have a lot of the benefits that come with the corporate structure. They can buy and sell their company stock but still benefit from avoiding double taxation. LLCs must specify a dissolution date in their articles of organization, but an S corp remains in existence until its shareholders decide to liquidate the company.
Why Might an S Corp Want to Own an LLC?
S corps can look to form subsidiaries or form LLCs for various reasons. For instance, LLCs do allow more flexibility than S corps when it comes to ownership and profit distribution. Flexibility in profit distribution is helpful when you have members who offer much in the way of handling day-to-day responsibilities with the company, also called "sweat equity," but perhaps didn't have as large an initial contribution as another member. S corps are required to distribute shares proportional to shareholders' capital contributions, but LLCs are not.
Another common reason an S corp might want to own a subsidiary is to protect a certain valuable asset from liability should the parent company come under legal trouble. They could distribute the asset to shareholders, but this opens the shareholders up to taxation and possible inconvenience in the responsibility of protecting the asset. This depends on what the asset is. If the company is trying to protect something that doesn't generate any revenue, it might be beneficial for them to create a subsidiary in order to do business and have the parent company simply hold the asset.
Entity Options for an S Corp Subsidiary
If an S corp wants to form a subsidiary company, it has three entity types to choose from:
- C corp
- Qualified subchapter S corp, or QSub
Choosing the qualified subchapter S corp entity type for a subsidiary company of an S corp allows the S corp to maintain all of its tax benefits of being an S corp. The assets of the QSub are viewed as assets of the parent company, so they don't benefit from the liability protection an LLC would.
A single-member LLC is a good choice because it offers the taxation benefits of an S corp, but also the liability protection of a C corp. If holding companies and subsidiaries are kept separate, the assets of one holding company can't be seized in the event that the other holding company is in legal trouble. Parent companies frequently take advantage of this by forming various subsidiaries to each protect different assets.
Corporations Serving as Partners
Both C corps and S corps can be partners in a partnership. General partnerships are viewed as business relationships between individuals or companies, but aren't legal structures. Technically, corporations are viewed as individuals in the eyes of the IRS and the law, so they can act as business partners.
General partners in partnerships can be held liable for legal issues with the partnership, but corporations need to be careful not to make their shareholders also liable in such cases. If the legal issues arise due to personal negligence on the part of the owner, they could be held liable. Owners of S corps that are partners in general partnerships are usually protected from liability through the S corp structure.
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