In many situations, one business entity holds ownership, either in part or whole, of another business entity. However, this is not always possible under IRS rules. So, can a limited liability company (LLC) own an S corporation (S-Corp)? The answer, as is often the case, is that it depends on the situation.
What is an LLC?
An LLC is an increasingly popular business structure for startups, offering liability protection for ownership and greater flexibility than a corporation, particularly in terms of taxes. The LLC itself does not pay taxes. As a “pass-through” entity, income passes through the business to the owner or owners, who report it on their personal tax returns. An LLC is created by filing paperwork with your state, and nominal fees are involved.
An LLC offers its owner or owners, who are called members, considerable flexibility in terms of management. You can choose your management and operational structure and decide how you want to be taxed. Your LLC can have a single member or multiple members, all of whom have personal liability protection, meaning your personal assets are not at risk if you cannot pay business debts or are involved in a lawsuit.
What Is an S-Corp?
An S-Corp refers to a business’s tax classification. It is a corporation or LLC that, by meeting certain requirements, can be taxed as an S-Corp. As with an LLC, with an S-Corp income passes through the business to shareholders or owners, without that income being taxed as corporate income. In contrast, in a regular corporation, also known as a C-Corp, the corporation is taxed as well as the dividends shareholders receive, which is sometimes referred to as double taxation.
A corporation or LLC can be classified as an S-Corp if it has 100 or fewer shareholders or members. Shareholders pay taxes on their pass-through income at their personal income tax rates.
Can an LLC Own an S-Corp?
Under the IRS rules, S-Corp shareholders:
- May be individuals, certain trusts, and estates and
- May not be partnerships, corporations, or non-resident alien shareholders
If an LLC has more than one member, it is taxed as a partnership unless it elects to be taxed as a corporation. This means that under IRS rules, the LLC is considered a partnership or a corporation and therefore cannot be an S-Corp shareholder. So, in this case, the answer to the question is no, an LLC cannot own an S-Corp.
But if an LLC has only one member and has not elected to be taxed as a corporation, it is taxed as a sole proprietorship and therefore is considered a disregarded entity by the IRS. This means that the LLC files no federal tax form. Profits are passed through to the sole member, who reports the LLC income on their personal tax return.
In this case, the LLC can own an S-Corp under IRS rules. So, a single-member LLC that has not elected to be taxed as a corporation can own an S-Corp.
Why Does the IRS Have This Rule?
Since an S-Corp has pass-through taxation, if an LLC owns a share of the S-Corp, S-Corp profits will pass through to the LLC. If the LLC has an owner that is not required to file U.S. taxes, that income would not be subject to taxation at all. This means that without this rule, someone could use an S-Corp to avoid taxation.
The only case in which an LLC can own an S-Corp is if the LLC has only one member and has not elected to be taxed as a corporation. If you are still not sure about your situation, it’s recommended that you consult with an attorney for advice.