What Is an S-Corp?
An s-corporation, or s-corp, is similar in form to the well-known corporation structure (c-corporation). S-corps elect a special tax status with the Internal Revenue Service, which allows them to be viewed as a disregarded entity. When it comes to taxation the S-corp is treated like a sole-proprietorship while remaining like a corporation in every other way.
This means that s-corps avoid the double taxation that c-corps experience by passing the corporation’s profits onto its shareholders. The s-corporation’s shareholders then report the income and losses on their personal income tax return. This tax election is available for holding companies.
Can S-Corps Own LLCs?
If you are wondering if an S-Corp can own an LLC, the answer is: Yes!
An S-Corporation holding company is an available option. Generally, LLCs are preferred to corporations thanks to the simplicity they offer. If your accountant recommends utilizing an S-corporation, then it is best to use an LLC taxed as an S-corp for your parent company.
S-corporations and LLCs have a few similarities between them. Both S-corps and LLCs offer limited liability protection to their members and are considered pass-through entities by the Internal Revenue Service.
Regardless, LLCs enjoy a simpler formation process and general management structure than S-corporations. Additionally, LLCs are taxed under the self-employment tax just like a sole-proprietorship or partnership, unless it otherwise files to be taxed like a corporation.
While S-corporations do have more restrictions than other tax elections, there remain many benefits to the S-corporation structure. S-corps have the ability to buy or sell company stock and enjoy perpetual succession until shareholders vote to liquidate, whereas LLCs must determine a dissolution date in their articles of organization with the state.
Benefits of an S-Corp Forming an LLC
There are a variety of reasons why an S-corp may want to form an LLC. For example, in terms of ownership structure and company profit distribution, an LLC offers more flexibility than that of an S-corporation. This flexibility can be useful when members play different roles within the company or make varying initial contributions. S-corporations require that shares be distributed proportionally to shareholder contribution. However, the flexibility of the LLC does not have this requirement, allowing you to distribute profits as you see fit.
Another benefit to why an S-corp may want to form an LLC is the ability to protect valuable assets in the event its parent company experiences legal troubles. It does, however, depend on the asset type, as distributing the assets to shareholders in this case might burden them with taxation.
Single-member LLCs offer the tax benefits of an S-corp, as well as the liability protection offered by corporations. When holding companies and their subsidiaries are kept financially separate, one holding company’s assets cannot be seized if the other holding company experiences legal trouble. Holding companies can take advantage of this benefit by forming subsidiaries to protect their various assets.
S-Corporations and Taxes
If a corporation wants to elect S-corporation status, it must meet certain criteria in order to pay corporate tax. An S-corp must adhere to the following criteria:
- It must have fewer than 100 shareholders.
- It can only have one class of stock.
- Shareholders can only be made up of individuals, estates, or certain trusts.
- Shareholders cannot be business entities such as corporations or LLCs.
- Shareholders must be U.S. citizens or legal residents.
When a corporation elects to be viewed as an S-corporation, it gains important tax benefits. Not only does it offer shareholders the limited liability protection of a corporation but it is also able to avoid the double taxation that a corporation experiences. C-corporations must pay taxes on both their profits and then again on their personal tax returns as they include dividend payments. S-corporations, on the other hand, do not have to pay corporate taxes on its profits. Instead, these profits are passed on to the shareholders who then report it on their personal tax returns, therefore only facing one form of taxation.
The Internal Revenue Service approves an S-corp’s disregarded entity status with an understanding that the company will accurately track profits and ensure that shareholders report that income on their personal tax return. If an S-corp were to try and pass profits on to a shareholder that did not meet the necessary criteria for S-corporations (for example: not a US citizen or legal resident), the company would lose its S-corp designation. It would then revert back to a corporation and begin to be taxed as a corporation, as well.