Can an S-Corp Own an LLC?

By William Pirraglia

An S corp may own up to 100 percent of an LLC, or limited liability company. While all but single-member LLCs cannot be shareholders in S corporations, the reverse -- an S corporation owning an LLC -- is legal. The similarity of tax treatment for S corps and LLCs eliminates most of the common concerns about IRS issues. Both structures "pass through" profits and losses to their owners for personal income tax submission.

S Corporation Advantages versus LLC

S corps are not legally different from C, or standard, corporations. S corp owners simply choose a different tax treatment with other corporation issues intact. They enjoy some benefits including offering stock, the ability to be sold or purchased as desired, perpetual existence, tax-free benefits like insurance, retirement plans, and travel, and changing ownership doesn't need to affect management. These features are unavailable to LLCs. For example, LLCs are legally designed to have a defined lifespan. Corporations are forever, unless liquidated by their stockholders. Conversely, some states even statutorily limit LLCs to having a 30-year maximum existence.

LLC Advantages versus S Corp

It is less expensive to form an LLC. Much less documentation and other requirements are needed to create and manage an LLC. Owners -- called members -- are not restricted in number or citizenship, as with S corps, with no limit on the number of owners or U.S. citizen mandates. This gives LLCs the opportunity for attract foreign investors. Wide flexibility to structure the company as you wish, even treating it like a sole proprietorship in single member LLCs.

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S Corp Motivation to Own an LLC

Because of the similar tax treatment options of both organizations, there is seldom an overriding tax benefit to S corps owning LLCs. However, the total flexibility offered by LLCs can be attractive to S corps. For example, assume that three LLC owners, who are known as members, invest $50,000, $40,000, and $10,000 each. In a corporation, the $10,000 stockholder is entitled to only 10 percent of the profits. However, the LLC members could decide to divide profits equally. In other cases, an S corp may see a new product or marketing opportunity with circumstances that make owning an LLC for this opportunity advantageous. Buying or forming an LLC, owned by the S corp may be operationally more cost efficient.

An LLC Owning an S Corp

Some LLCs cannot own S corps, just as one S corp cannot own another S corp. Since both are "pass through" entities that have no tax liability themselves, pass-through companies owning other pass-through organizations would benefit only the tax preparers, not the owners. There is, however, one way for an LLC to own stock in an S corp. A single member LLC, taxed as a sole proprietorship, is called a "disregarded entity" by the IRS. Treated like an unincorporated individual, this LLC could own stock in an S corp and receive profits in relation to its ownership percentage.

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Tax Consequences of Converting a C-Corp to an S-Corp

Corporations are business entities formed under state law that exist separately from their owners. An S corporation is simply a C corporation that has elected to be taxed as a pass through entity. Converting from a C-corp to an S-corp has significant tax implications, which include potentially lowering the overall tax burden on the shareholders, but also changing who reports the income each year and limiting when the income can be reported on the shareholder's tax returns. However, an S-corp must meet several criteria, including having less than 100 owners, only having U.S. resident or U.S. citizen individuals and certain entities as shareholders, and not having more than one class of stock.

Why Limit the Number of S Corporation Shareholders?

The number of shareholder-owners in a Subsection S corporation, commonly known as an S corp, was restricted to 10 when the legislation creating S corps was passed by Congress in 1958. Legislation in 2004 increased the number of shareholder-owners to 100 and enabled family members to be counted as only one shareholder. Congress restricts the number of shareholders because of the nature of an S corp: It is intended to be a way for a family business or small business to obtain the same protection from personal liability that a giant company enjoys, while enabling the S corp shareholder-owners to be free from corporate taxes that larger businesses must pay.

Can an S Corp Have Two Classes of Stock?

An S corp cannot have two classes of stock. The IRS sets a number of requirements for S corporations, one of which is that the company have only one class of stock. Violating this requirement for your S corp, even accidentally, can have severe tax consequences both for your business and your personal income tax return.

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