Can an S Corp Own Another S Corp?
Can an s corp own another s corp? It's a question many business owners ask as they establish the right organizational structure for their companies.3 min read
2. Can an S Corp Own Another S Corp?
3. QSSS Tax Treatment
4. Losing QSSS Status
5. S Corp Regulations
Updated October 22, 2020:
Can an s corp own another s corp? It's a question many business owners ask as they establish the right organizational structure for their companies. The short answer is yes, but only under specific circumstances.
The biggest advantage of having a business structured as a subchapter S corporation is that it isn't required to pay corporate taxes on its income. The “S” in S corp stands for small business. S corps are designed to only be used by small businesses, so there are tight laws on who can own them and how they must be run.
S Corps and Taxes
If a corporation chooses to be treated as an S corp, it receives two major tax benefits from the IRS:
- Limited liability protection for shareholders, the same treatment that is given to all corporation
- Inability to be doubly taxed, which most C corps face
C corporations pay taxes on their profits and also pay dividends to shareholders. Shareholders are required to include dividends in their personal tax returns, which leads to double taxation. S corps don't pay corporate taxes on their profits, which means they pass the profits to the owners and are only taxed once.
Can an S Corp Own Another S Corp?
According to U.S. law, an S corp is limited to 100 shareholders or less. To be legal, shareholders must be U.S. citizens, legal residents, estates, or certain types of trusts.
In general, corporations aren't allowed to be shareholders. The only exception that allows an S corp to own another S corp is when one is a qualified subchapter S subsidiary, also known as a QSSS. In order to be considered a QSSS, all of the shares of the owned S corp have to be owned by one S corp.
As an example, if you have a computer repair business structured an S corp that has 20 shareholders and want to spread to the cellphone repair business, you can create a new S corp. Establishing the new business as an S corp protects the first business from being sued or being financially responsible if the new business fails. The original business can own the new business as an S corp if it owns all of the shares.
QSSS Tax Treatment
According to the law, a QSSS runs the same way as an S corp. Each entity is viewed as distinct from the owners, which means that if the S corp that is owned runs into legal or financial trouble, the owners aren't held responsible and don't have anything more at risk than what they have invested in the business.
When it comes to taxes, the IRS basically doesn't act like the QSSS exists. The assets, liabilities, expenses, and income of the owned company are treated like they are part of the company that owns it. Because the parent company is also an S corp, it doesn't pay corporate income taxes on the profits that it makes or that the owned company makes. The profits from both companies are passed on to the shareholders who pay personal income tax on the dividends they receive.
Losing QSSS Status
The IRS is very strict with its rule that a QSSS has to be 100 percent owned by the parent company. As soon as the parent company sells even one share of its QSSS, the owned company loses its QSSS status.
The owned company also loses its S corp status because the ownership structure doesn't follow the legal requirements of an S corp, which means it then has to pay corporate income taxes. If an S corp loses its status, it isn't allowed to get that status back for five years.
S Corp Regulations
An S corp is a corporation that fulfills specific criteria to be free from paying corporate tax. In order to maintain that status, an S corp must follow detailed rules and do certain things, including:
- Have fewer than 100 shareholders
- Only have shareholders who are individuals, estates, or certain kinds of trusts
- Only have shareholders who are U.S. citizens or legal residents
- Have just one class of stock
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