Key Takeaways

  • S Corp Ownership Rules: Generally, an S corporation cannot own shares in another S corporation unless it owns 100% of the shares and the subsidiary is treated as a Qualified Subchapter S Subsidiary (QSSS).
  • Tax Implications of S Corp Ownership: The tax treatment of a QSSS means the subsidiary's income and losses flow directly to the parent S corporation, avoiding double taxation.
  • Passive Income Limitations: If an S corp owns a C corporation or an LLC, it must be cautious of excessive passive income, which could trigger a loss of S corporation status.
  • S Corp Conversion Considerations: If a QSSS fails to maintain its S corp election due to ownership or income structure changes, it may default to C corp status.
  • IRS Compliance and Filing Requirements: S corporations and their subsidiaries must adhere to IRS filing guidelines, including the proper election of S corp status using IRS Form 2553.
  • LLC and C Corp Ownership: While an S corp cannot own another S corp in most cases, it can own shares in a C corporation or an LLC, but certain restrictions apply to ensure pass-through taxation benefits.
  • Legal and Business Strategy Implications: Structuring an S corp with subsidiaries can provide liability protection and operational flexibility, but careful tax planning is needed.

The answer to the question of "can an S corp own an S corp?" is yes, but it must own 100 percent of the shares of that S corp's stock and treat it as a subsidiary. An S corporation is a corporation established by state law that has elected to be treated under Subchapter S by the IRS for tax purposes. An S corporation may be called a Sub-S.

Many businesses opt for beneficial S corporation status because this type of business entity is not subject to corporate taxation on income. This election is made by filing IRS Form 2553. Congress initially created this designation to be used exclusively by small businesses. For this reason, the law only allow an S corporation to purchase shares of a second S corporation in rare and exceptional circumstances.

General Requirements for S Corporations

The U.S. Code indicates that an S corporation must:

  • Have fewer than 100 shareholders
  • Be incorporated domestically
  • Be owned by individuals, estates, and/or qualified trusts
  • Not be owned by corporations, partnerships, or nonresident aliens
  • Issue only one class of stock

When one S corp has purchased all the shares of another S corp, the latter is known as a QSSS (qualified Subchapter S subsidiary).

Qualified Subchapter S Subsidiary (QSSS) Rules

A Qualified Subchapter S Subsidiary (QSSS) is an S corporation that is 100% owned by another S corporation. Once an S corp elects to treat a subsidiary as a QSSS, the subsidiary is disregarded as a separate entity for federal tax purposes, meaning all income, deductions, and credits are included on the parent S corporation’s tax return.

Key requirements for a QSSS election include:

  • The parent S corp must own 100% of the subsidiary's stock.
  • The subsidiary must meet the eligibility criteria of an S corporation.
  • The parent must file IRS Form 8869 to make the QSSS election.

Benefits of a QSSS:

  • Pass-through taxation is maintained, preventing double taxation.
  • The parent S corporation simplifies tax filings by consolidating its subsidiary’s earnings and losses.
  • Limited liability protection remains in place for the subsidiary.

However, a QSSS may not be recognized as a separate entity for state tax or liability purposes in some jurisdictions, requiring careful legal structuring.

Tax Treatment of S Corporations

When a corporation elects to be taxed as an S corp, it receives the benefit of limited liability protection. It also avoids the double taxation that is an issue for C corporations. These businesses must pay taxes on their profits as well as on the profit dividends they receive as shareholder income. With an S corp, shareholders simply report business profits and losses on their individual tax returns (pass-through taxation).

Passive Income Considerations for S Corps with Subsidiaries

S corporations are subject to strict limitations on passive income. If an S corp owns a subsidiary that generates significant passive income (such as rental income, dividends, or royalties), it risks termination of its S corp status.

IRS rules dictate that:

  • If more than 25% of an S corporation’s gross receipts are from passive sources for three consecutive years, the S corp may be required to pay an additional tax.
  • If this issue persists, the S corporation could lose its tax election and be converted into a C corporation, leading to double taxation.

To avoid these risks, S corps with subsidiaries must carefully manage their revenue streams and ensure active participation in business operations that generate income.

Owning Stock in Another S Corporation

Because an S corp must be owned by individuals, trusts, or estates, in general, S corp stock cannot be held by another S corporation, a C corporation, an LLC, or a partnership. Purchasing shares of another S corporation voids that company's election of S corp treatment. This means that the company in question would be taxed as a regular corporation and thus be subject to double taxation.

With the exception described above, the S corporation must own 100 percent of another S corporation. The latter is no longer considered a separate income tax entity, and all its profits and losses are included in the tax return of the parent S corporation.

For example, if you own a landscaping business that is structured as an S corp and want to expand into the plant nursery business, you can form a second S corporation for the subsidiary business with your original S corp as the sole shareholder. This protects the original S corp from liability if the subsidiary is sued or becomes a financial failure.

Consequences of an S Corp Owning Another S Corp Without QSSS Election

If an S corp inadvertently acquires shares in another S corporation without making a QSSS election, it can jeopardize both entities' tax statuses.

Consequences include:

  • The acquired S corporation could be forced to revoke its S corp status and revert to C corporation status.
  • The owning S corp may be deemed ineligible for S corp treatment, losing its pass-through tax benefits.
  • The IRS may impose penalties and require the entity to reclassify income for tax purposes.

To avoid these outcomes, S corps should consult with tax professionals before acquiring interests in other corporations.

Losing S Corp Status

If an S corp that owns a QSSS sells a share to another individual, trust, or estate, the QSSS will lose its S corp status and is thus subject to corporate taxes. What's more, it will be disallowed from regaining S corp status for half a decade.

Owning Stock in a C Corporation

An S corporation is allowed to own stock in one or more C corporations. If the S corp owns all the shares of a C corp, the latter is considered a subsidiary of the former. Purchasing C corp stock does not jeopardize S corporation status. However, profits and dividends will be subject to passive income limits unless the S corp shareholders actively participate in managing the C corp. 

Owning Stock in an LLC

An LLC, or limited liability company, offers many of the benefits of a corporation without the stringent legal and administrative requirements. While only a single-member LLC can own stock in an S corporation, an S corporation can own an LLC. Because they are treated similarly for tax purposes, double taxation is not a concern. However, if an S corporation purchases stock in an LLC that has elected to be taxed as an S corp, the LLC may lose this beneficial tax status.

How an S Corp Can Own an LLC Without Losing Tax Benefits

An S corp can own an LLC, but the tax implications depend on how the LLC is structured.

Key considerations include:

  • If the LLC is a single-member LLC (SMLLC), it is disregarded for tax purposes, meaning its profits and losses pass directly to the S corp.
  • If the LLC has multiple members and has elected to be taxed as an S corp, the S corp may not be able to retain its S corp status while holding membership.
  • If an LLC is taxed as a partnership, an S corp can be a member, but this may affect the S corp’s tax obligations.

Because LLC ownership structures vary, it is critical to analyze how the LLC’s taxation election will impact the parent S corporation’s tax liability.

Advantages of an S Corp Over an LLC

Benefits of an S corporation that do not apply to an LLC include the ability to sell stock, to be sold or purchased, to declare benefits such as health insurance on their taxes, and the fact that a change in ownership does not necessarily affect management.

Frequently Asked Questions

1. Can an S corp own multiple S corporations? Yes, but only if the parent S corp owns 100% of the subsidiaries and elects QSSS status for each one.

2. What happens if an S corp owns part of another S corp? Owning even a single share of another S corp without electing QSSS status can cause both entities to lose their S corp status.

3. How does an S corp elect QSSS status for a subsidiary? The parent S corp must file IRS Form 8869 and meet the ownership and eligibility requirements.

4. Can an S corp own a partnership? Generally, an S corp cannot be a partner in a traditional partnership, as partnerships are not eligible S corp shareholders.

5. What happens if an S corp exceeds the passive income limit? If an S corp has more than 25% of its gross receipts from passive income for three consecutive years, it may lose its S corp election and be taxed as a C corp.

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