Key Takeaways

  • A holding company cannot own an S corp directly, as S corporation shareholders must be individuals or certain trusts and estates.
  • However, an S corp can own subsidiaries, including QSubs, LLCs, and C corps.
  • A parent LLC cannot be a shareholder in an S corp, but strategic structuring (e.g., individuals owning both the LLC and the S corp) can allow similar outcomes.
  • A holding company may own C corps, which can in turn own S corps, though this may forfeit the S corp’s status.
  • Missteps in structure (e.g., ineligible shareholders) can lead to automatic termination of S corp status.

An S corp subsidiary is a situation in which an S corporation owns more than 80 percent interest in another corporation. An S corporation is considered a pass-through tax entity, which means that shareholders report all income, losses, credits, and deductions on their individual tax returns. This allows them to avoid double taxation since corporate income taxes are charged only on passive income.

To form an S corporation, all shareholders must agree in writing by signing and submitting IRS Form 2553. This option is only available to corporations that:

  • Are domestic
  • Have 100 or fewer shareholders
  • Do not have corporations, partnerships, or nonresident aliens as stockholders
  • Issue only one class of stock
  • Are not an insurance company, bank, or international sales corporation

Can S Corporations Own Subsidiaries?

Before 1997, an S corporation was not allowed to own more than 80 percent of the shares of an active subsidiary. This restriction was removed to allow taxpayers to create different corporate entities for different types of business. Congress thus allowed for both parent-subsidiary and brother-sister corporate arrangements. An S corporation can purchase stock in a domestic subsidiary and flow income through this subsidiary to shareholders, creating substantial tax savings. That's because the income will be taxed at the lower individual taxpayer rate rather than at the corporate rate.

An S corporation can create a subsidiary as either a limited liability company (LLC), a C corporation, or a qualified subchapter S subsidiary (QSub). An S corporation can be 80 percent or more owned by C corporations that act as subsidiaries. These subsidiaries can file a single tax return, but the parent S corporation must file a separate return.

When the S corporation receives dividends from these subsidiaries, they are not taxed as passive investment income. This allows the S corp to avoid the scenario where its beneficial tax status is revoked because of accumulated earnings and profits. 

Because an S corporation cannot have another corporation as a shareholder, most subsidiaries cannot be treated as S corporations. The exception is a QSub, also called a QSSS. In this case, the S corporation owns the entire subsidiary and elects S taxation for the company in question. This subsidiary must be an eligible S corporation. With the QSSS election, the subsidiary is treated as a disregarded tax entity, not as a separate corporation. 

This means that the subsidiary's income, assets, deductions, and liabilities pass through to the parent corporations, as do accumulated earnings and profits, built-in gains, and passive income. A QSub is not required to file a separate federal income tax return since its financials are consolidated on the S corp return. 

Establishing a QSub provides each separate business entity with limited liability protection from financial issues that affect related entities. The taxation of this type of structure is complex. However, it allows S corporations to establish discrete legal entities without affecting pass-through taxation. When an existing corporation transforms into a QSub, it is typically considered a tax-free subsidiary liquidation. 

Take caution when selling a QSSS if its stock was purchased at a premium by the S corporation. This can create a tax pitfall that can be avoided by replacing a stock purchase with asset negotiation or adjusting the purchase price of the stock. The best course of action is to consult a tax attorney or CPA.

Can a Holding Company Own an S Corp?

The short answer to the question “can a holding company own an S corp” is no, at least not directly. Under IRS rules, only eligible shareholders are allowed to hold ownership in an S corporation. These eligible shareholders include:

  • U.S. citizens and resident individuals
  • Certain types of trusts (grantor and electing small business trusts)
  • Estates

Ineligible shareholders include:

  • Partnerships
  • Corporations (including holding companies or LLCs taxed as corporations)
  • Non-resident aliens

This means that if a holding company is structured as an LLC or C corporation, it cannot directly own shares in an S corporation. If such a transaction were attempted, it would invalidate the S corp election and convert the entity to a C corporation.

Legal Workarounds for Ownership

While a holding company cannot directly own an S corporation, business owners may still accomplish similar goals through compliant structuring:

  • Individual Ownership Structure: The holding company’s individual owners may each hold shares in the S corporation directly, effectively controlling both entities.
  • Tiered Ownership with C Corp: A holding company may own a C corporation, and that C corporation can operate or acquire another C corporation. However, the C corporation still cannot be an S corp.
  • Brother-Sister Structure: A single individual or group may own multiple S corps and LLCs, creating a de facto holding structure while remaining compliant with IRS rules.

Always consult legal or tax professionals before attempting any restructuring to ensure it does not inadvertently terminate an S corp’s tax status.

Alternative Structures

Instead of creating a subsidiary to hold a valuable asset, the asset in question could be distributed to shareholders. However, they would have to pay tax on its appreciation as well as the built-in gain tax if applicable.

The S corp could also create a subsidiary to hold the asset, but this subsidiary could be liable for claims against the parent company, putting the asset at risk. The exception is when the subsidiary is a limited liability company (LLC).

Another option is to transfer the main business to a subsidiary and hold the asset in the parent company. This is a common solution if art or something else that wouldn't generate liabilities is the asset in question. Finally, a new holding company could be created with the original corporation and a new subsidiary as its two subsidiaries.

Using a Holding Company With an S Corp

Although a holding company cannot directly own an S corp, it can still play a role in broader business structuring. Entrepreneurs commonly create a holding company structure with multiple business entities, some of which may be S corporations, others LLCs or C corps.

Common strategies include:

  • Creating Separate S Corps Under Individual Ownership: Instead of placing them under one holding company, each S corp is directly owned by the same individual(s), creating operational silos.
  • Using a Disregarded Entity: If the holding company is a single-member LLC (disregarded for tax purposes), it may appear as if the LLC owns the S corp. In reality, the IRS sees the individual owner as the shareholder.
  • Family Trust Holding: Trusts that qualify as S corp shareholders can hold shares on behalf of multiple family members, serving as a sort of centralized ownership tool.

Key Risks to Avoid:

  • Accidentally transferring S corp shares to an ineligible entity
  • Violating the single-class-of-stock rule
  • Exceeding the 100-shareholder limit through complex trust or family holdings

Frequently Asked Questions

  1. Can an LLC be a shareholder in an S corp?
    No. LLCs are considered ineligible shareholders for S corporations unless the LLC is a disregarded entity owned by a U.S. individual.
  2. What happens if an S corp is owned by a corporation?
    If a corporation (including a holding company) owns an S corp, the S corp loses its special tax status and is treated as a C corporation by the IRS.
  3. Can I use a trust to own an S corp?
    Yes, but only certain types of trusts—such as grantor trusts and ESBTs (electing small business trusts)—are eligible to be S corporation shareholders.
  4. Can an S corp own another S corp?
    No. An S corporation cannot own another S corporation directly. However, it can wholly own a QSub, which is treated as a disregarded entity.
  5. What’s the best way to structure a holding company with an S corp?
    Use individual ownership or trusts for the S corp shares, while managing the holding company and other entities separately for liability protection and asset management. Always consult a tax attorney or CPA for guidance.

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