When it comes time to expand their businesses, entrepreneurs must carefully choose the types of structures they use when acquiring other entities.
Those who are currently structured as S corporations often wonder what options they have when acquiring another business, particularly an LLC, and whether this is even possible. The answer is yes, it is.
An S corp can own an LLC, and there are various advantages to doing so. There are also some important considerations to keep in mind that business lawyers can help S corp owners understand.
What Is an LLC?
The abbreviation “LLC” stands for "limited liability company." Limited liability companies afford significant personal liability protection to the owners of the business, who are also known as members. LLCs need only comply with limited business regulations, as the income they generate flows through members' personal income tax returns.
Because LLC members do not get paid through a company payroll account, the money that members receive is not tax deductible and is therefore subject to various taxes, including Social Security and Medicare.
What Is an S Corporation?
Despite its name, an S corporation is not really a business entity or structure. Instead, it is a type of tax designation frequently chosen for its tax advantages. Because of these advantages, various business structures, including LLCs and corporations, may elect S corporation status if they meet the eligibility requirements.
S corporation eligibility requirements include having the following:
- 1,000 or fewer shareholders in the business;
- U.S. citizens or permanent legal residents as shareholders;
- Shareholders who are private individuals, not business entities;
- Only one class of stock;
Many entities that choose S corporation status, such as C corporations, typically do so to avoid exposure to double taxation. For example, if a C corp does not elect S corp status, its profits will be taxed at the corporation level, then again at the individual level when paid to shareholders as dividends.
However, if a C corporation elects S corp status, its profits will not be exposed to corporate income tax and will be taxed solely through the income tax returns of the individual shareholders. Needless to say, this can help its owners avoid a significant financial burden.
What Is a Holding Company?
A holding company is a business entity that has acquired a requisite amount of stock in another company, allowing it to exercise some degree of control over that company.
Holding companies are not businesses in the traditional sense, as they do not produce goods or services. Instead, entities of this nature exist primarily to hold shares of and investments in other companies.
Although a holding company owns controlling assets in another company or companies, it typically does not participate in the day-to-day running of these companies. Rather, it exercises general oversight capacities and certain management powers.
One benefit of a holding company is the protection it affords against the losses incurred by its subsidiaries. For example, if a subsidiary company experiences bankruptcy, the creditors may not go after the holding company.
Can an S Corporation Own an LLC?
With all of the different structuring and ownership options available in the business world, many small business owners and entrepreneurs often wonder if it is possible for an S corporation to own an LLC.
The answer is yes — owners of LLCs can be S corporations. Despite strict rules regarding who may be a shareholder in an S corporation, the rules regarding what entities an S corporation may purchase are much laxer.
One popular way an S corp acquires an ownership interest is through a holding company. An S corporation that owns an LLC as a holding company benefits greatly from significant asset protection. If the LLC gets in trouble with creditors, the S corporation holding the company's assets is off-limits to those creditors.
Another benefit of using an S corporation holding company to own an LLC is for estate-planning purposes. When someone passes away, the assets in their name may be subject to significant estate taxes. However, assets held in a holding company are not.
Other reasons for using an S corp holding company in this context include mergers and acquisitions and the future sale of a business.
Are There Any Restrictions on an S Corporation Owning an LLC?
LLCs are popular entity structures precisely because there are few restrictions for forming and owning one. For S corps, the only real restriction is the number of LLCs an entity of this nature can own. Since S corps can have up to 100 shareholders, an S corporation can potentially own or be a member of 100 LLCs.
Additionally, the restrictions that S corps have regarding profit distribution largely disappear when operating through an LLC. As mentioned, S corporations must distribute profits in proportion to shareholders' capital contributions, whereas LLCs have the freedom to distribute profits disproportionately to said contributions as desired.
Can an S Corporation Own a Single-Member LLC?
Yes. An S corporation can be the sole member of an LLC. Members can be any number of business entities, including S corporations. The single-member LLC's income will be taxed on a pass-through basis.
Can an S Corp Own a Multi-Member LLC?
Yes. An S corp may own a multi-member LLC. Multi-member LLCs are limited liability companies with more than one member, and S corps can be part of LLCs regardless of the number of owners.
Can an LLC Own an S Corp?
Is the reverse also true? Can an LLC own an S corporation? The answer is no, in most cases.
The only exception to this prohibition is if the LLC is a single-member LLC that has elected to be treated as a disregarded entity for federal income tax purposes (meaning it has not opted for tax treatment as a corporation) and complies with S corporation shareholder requirements.
Why Would an S Corporation Own an LLC?
If you have S corporation status and are considering becoming a member of an LLC, you should know that doing so could be beneficial to the growth of your business, depending on your circumstances and future plans.
- Brand Expansion into New Markets: If your S corporation is interested in expanding into new markets, forming an LLC separately and under the auspices of the S corporation will enable you to do so and keep the new venture separate from your core business.
- Asset Protection: Forming an LLC as a subsidiary of your S corp is also advantageous if you want to protect valuable assets from creditors. One way this can occur is by transferring assets out of the parent S corp business entity into an LLC to protect them in the event that the parent company runs into trouble.
- More Options for Profit Distribution: When an S corp distributes profits, it must do so according to each shareholder's capital contributions. However, with an LLC, a member's monetary contribution does not influence how profits must be distributed. Instead, LLC members can choose based on other criteria, such as a member's physical and personal non-monetary contributions to the running of the LLC.
As you can see, the advantages are many for S corps who want to own LLCs. However, there are important tax ramifications for doing so that should be discussed with an experienced business attorney.
What Is the Best Option for Your Business? Speak with a Buffalo Business Attorney!
Choosing to buy an LLC is a decision that should not be taken lightly. Lawyer For Business has clients throughout New York who rely on us for fast, effective legal guidance and services.
Whether you have a sole proprietorship or are one of many S corporation shareholders, our S corp attorney can help you register a new entity, guide you through the purchase and sale of an LLC, and more. Contact us today for assistance.
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