Can an S Corporation own an LLC in the US? An LLC or Limited Liability Company is an entity that provides liability protection to the members of the owners and it has an added advantage that it requires lesser compliance required and filing of taxes is also simpler due to the income and losses that flow via the owner’s tax returns.
The members are not on the payroll of the company, so the money they get or pay themselves is not a part of the tax-deductible expense. Although they have to pay income tax, Medicare tax, and others, on the business’s profit.
The owners of both LLCs and S Corporations are not responsible personally for debts, losses, or liabilities, they are responsible as the business owners. They are both pass-through tax entities.
1. What is an S Corporation?
An S corporation is a classification of the tax bracket more than a business entity, implying that an LLC or a C corporation can apply to it by submitting form 2553.
So, any LLC that chooses to take up the S corporation taxation treatment will have to do low on Medicare and social security tax burdens.
This is because they pay the Social Security tax and the Medicare Tax only on the income that they receive on the company payroll.
Although it remains a pass-through tax business entity, where the income and losses flow out of the owner’s tax returns, there is some extra tax filing and paperwork required for it.
Similarly, when a C corporation chooses the S Corporation tax treatment their idea is to escape from the double taxation that would happen if it was not the case.
Once the tax is deducted when profit is earned at the corporate level and the second time again on the individual level, via shareholders.
In an S Corporation, you can easily transfer the ownership, as the stock can be transferred just by fulfilling the IRS requirements.
However, for an LLC it is not, the hold-up is that the other member/members should approve the transfer. In an S Corporation, the owner can be made to look like an employee unlike in an LLC. Hence, providing a better self-employment tax structure.
2. Why Would an S Corporation Own an LLC?
An S Corporation may be benefitted by owning an LLC in the following cases :
- If a business wants to diversify or bring in something now in terms of a product line or onboard newer markets, forming an LLC under an S corporation would be a really good idea. This would help the LLC to diversify in a manner that they can focus on the new line while retaining the old or core business as well.
- There can be times when you want to protect your assets in case of any legal or financial troubles and one way to achieve this is to have an LLC as a subsidiary of an S Corporation. When this happens you can shift the ownership of the assets from the parent company, hence protecting them from the creditors.
- When an LLC is taxed in the S corporation way, it requires you to distribute profits to the shareholders based on their capital contributions. However, in an LLC they can divide profit based on which member is managing the company better, or who is handling all the operations despite the fact how much money they have invested in the company.
3. Can an S Corp Own an LLC?
Corporations function in a manner that they distribute their ownership by selling shares. This gets more fascinating because you can sell these shares to pretty much anyone in the whole world.
An LLC can buy any business entity, they have legal allowance for property and assets and unlike an S Corporation, they can work like an individual, but in an S Corporation, they can only be owned by actual individuals.
So, an LLC can not own an S Corporation but an S Corporation can own an LLC and the IRS allows for the same when it is declared that the profits are tracked and are treated as the individual’s (owner) income, on his/her taxes, or of the other members if any.
Any income provided to the individual or the business that is not under tax-deductible income is not present for the IRS.
For an S Corporation to gain the identity of disregarded entity status they must follow these rules:
- The shareholders must be individuals, trusts, tax-exempt organizations, or estates and the individuals must also be citizens of the United States.
- These individuals can not be LLCs Corporations, or any other business entities.
4. Holding Company
One of the most popular ways of owning an LLC by an S Corporation is as a holding company. Let’s understand what a holding company is.
A holding company is a business entity that holds a sufficient amount of shares and stocks in another company so that it can control its management and direction.
So, it does not perform any operative function like production or services but just stands there to hold shares or investments.
These investments can be marketable securities or rental properties on the portfolio and any income generated from the investments stays in the holding company which eventually goes to the owner as a dividend.
A holding company is also another tool for the protection of your assets, if you are using a holding company then the creditors of the operating company do not have access to the assets.
These can also be used for federal estate tax planning, so when you are dying the tax is not an issue; because any asset that you own in your name is not liable for the same.
5. Final Notes
An S corporation can own an LLC, however, the other way round does not work out. Several guidelines have to be followed for the same.
Holding a company is one of the ways to get it done, however, there is more to the same. Keep reading, and keep growing!