The Ultimate Guide to S Corporations Owning LLCs: What You Need to Know

An LLC or Limited Liability Company 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. 

We walked to experts on whether a S Corporation and LLCs are right for businesses, and here is what they said.

S Corporations owning LLCs showcases the nuanced strategies businesses can employ to optimize taxation, protect assets, and streamline operations. Understanding these structures and their implications is crucial for effective business planning and financial management.”

David Lee, Professor of Business Law and Taxation

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. 

The strategic use of an LLC as a subsidiary under an S Corporation can provide businesses with a valuable tool for asset protection and operational diversification. This structure is particularly advantageous for expanding into new markets or product lines while safeguarding the parent company’s assets.”

Emily Roberts, Financial Strategist and Investment Advisor

We interviewed David J Greiner, Esq., Owner of David J. Greiner Law Corp., on deciding whether an S Corporation owning an LLC is the right strategy for their business. Here is what he had to say:

“Deciding whether an S Corporation owning an LLC is the best structure for a business largely hinges on the specific goals and context of the business itself.

In my experience, when transitioning Greiner Buick GMC from its original operating structure to a more complex ownership arrangement involving an S Corporation, we had to consider multiple facets meticulously.

Taxation is often the initial concern. An S Corporation owning an LLC allows the flow-through of profits and losses which avoids double taxation—profits are taxed at individual owner levels and not at the corporate level.

This was crucial for us as it simplified the tax process significantly and retained more capital for business reinvestment.

Asset protection is another critical factor. This structure allowed us to protect personal assets from business liabilities effectively. For example, any lawsuits or business debts targeting the LLC would not affect the personal assets of the S Corporation’s shareholders.

This dual layer of protection provided peace of mind and financial security, encouraging more flexible and aggressive business strategies.

Lastly, operational flexibility must be considered. S Corporations have stricter operational requirements like shareholder compensation regulations and mandatory meetings. However, owning an LLC can offer more flexibility in day-to-day operations.

In our case, this setup allowed us to streamline decision-making processes and react more swiftly to market changes, as the LLC could operate with less formal structural requirements than a standalone S Corporation.

Each business scenario is unique, and while this structure worked efficiently for Greiner Buick GMC by blending liability protection, taxation benefits, and operational agility, it’s imperative to assess how these factors align with your specific business needs and long-term goals.

Consulting with a professional versed in both legal and tax implications remains crucial to navigate this complex decision optimally.”

2. Why Would an S Corporation Own an LLC?

Choosing an S Corporation status allows businesses to enjoy reduced tax burdens on Social Security and Medicare by only taxing payroll income. This strategic tax classification can lead to significant savings for eligible LLCs and C corporations.”

– Jane Smith, Corporate Tax Attorney

An S Corporation may be benefitted by owning an LLC in the following cases :

1. 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. 
2. 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. 
3. 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. 

The Icy WHiz team talked to M. Denzell Moton, Esq, Owner of Moton Legal Group, about the complex interplay between S Corporations and LLCs in business ownership structures. Here is what he said:

“In handling the complex structuring with S Corporations owning LLCs, my extensive work at Moton Legal Group dealing with business formations across different states has given me a nuanced understanding of how taxation, asset protection, and operational flexibility interplay in such arrangements.

Here’s how I use these experiences to navigate decisions for optimal structure. Taxation is crucial and often drives the structuring of decisions. The pass-through nature of an S Corporation owning an LLC can be beneficial, as it avoids the double taxation faced by C Corporations, allowing profits to pass through to the personal income tax returns of the shareholders.

This structure can be particularly advantageous in states with favorable tax rules for S Corporations and LLCs. For example, while working with a technology startup in Charleston, we leveraged South Carolina’s tax benefits by structuring the business as an S Corp owning an LLC, which resulted in significant tax savings and more funds available for reinvestment in the company.

In regards to asset protection, layering an S Corp and an LLC creates a robust shield for personal assets against business liabilities.

This dual structure allows for the LLC to handle operations, bearing the brunt of potential legal challenges or debts, while the S Corp adds an extra layer of protection and maintains the primary business assets securely.

This strategy proved effective when we managed to safeguard a client’s investments during a legal dispute involving their hospitality business, structured under this model.

Operational flexibility, however, needs careful consideration. While LLCs generally offer more operational agility, being owned by an S Corp can introduce certain bureaucratic elements typically associated with corporations, like the need for structured shareholder meetings.

Balancing these requirements with the operational style of the LLC’s management is vital.

We have often incorporated strategies that allow LLC managers ample operational freedom while ensuring compliance with S Corp obligations, promoting efficiency and responsiveness in business actions.

Understanding these factors and the interplay between different legal structures provides a tailored approach to each business scenario, ensuring alignment with both immediate needs and long-term goals.

Each case differs and demands a unique balance, and my guidance always relies on integrating these elements with the client’s specific circumstances and requirements.

Through informed decision-making, businesses can utilize these structures to foster growth while mitigating risks.”

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: 

1. The shareholders must be individuals, trusts, tax-exempt organizations, or estates and the individuals must also be citizens of the United States. 
2. These individuals can not be LLCs Corporations, or any other business entities. 

Andy Gillin, the Attorney & Managing Partner at GJEL Accident Attorneys, talked to the Icy WHiz on this. Here is an excerpt from the interview:

“When deciding whether an S Corporation owning an LLC is the right strategy, entrepreneurs should first think about their long-term business goals and the scale at which they plan to operate.

If the entrepreneur envisages quick expansion and the potential to attract investors, an S Corporation may be a more suitable option.

One of the key factors affecting this decision is the tax implications. An S Corporation allows the business owners to avoid the double taxation that often comes with a C Corporation structure: in an S Corporation, income is passed directly to the shareholders and taxed at their rates.

But interestingly, an S Corporation owning an LLC can combine the best of both worlds. Like S Corporations, an LLC offers pass-through taxation and it also provides its owners with limited liability protection.

Asset protection is another crucial deciding factor. Both S Corporations and LLCs provide owners with protection against personal liability for business debts.

However, an LLC may offer slightly more flexibility in terms of management and operation, as it doesn’t adhere to the stringent rules and regulations associated with S Corporations.

Operational flexibility is another major consideration. S Corporations have the burden of adhering to strict operational requirements, such as mandatory meetings and extensive record-keeping protocols.

On the other hand, LLCs are generally easier to maintain, have fewer state-imposed annual requirements and formalities, and offer more flexible management structures.”

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. 

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! 

Guest Author: Saket Kumar

Last Updated on May 17, 2024 by soubhik