Can your S-Corporation own an LLC? Yes, owners (members) of LLCs can be either individuals or legal entities, such as S-Corps, C-Corps, LLCs, or trusts.
What is an S-Corporation?
An S-corporation is not a formal business structure, it is a tax classification. Both LLCs and corporations can choose to be taxed as an S-corporation. In order to qualify as an S-Corp, the organization must meet the following requirements:
- Have no more than 100 shareholders
- All shareholders must be U.S. citizens or permanent legal residents
- Shareholders must be private individuals, e.g., not LLCs, corporations, or trusts
- S-Corps can only issue common stock shares with voting rights
Benefits of S-Corp Status
Members own LLCs and are not considered employees; therefore, they are not paid a salary. Instead, members are paid via distributions. However, if the LLC elects S-Corp taxation, the members can be paid a salary and collect distributions, each of which are taxed differently. Salaries are subject to both employment and income tax, but distributions are only subject to income tax.
The IRS allows employees of S-Corps to receive a “reasonable salary” with the rest of their compensation being paid in distributions. Considering that employment tax is typically at a rate of 15%, electing S-Corp status can save you significant money in taxes.
What is a Holding Company?
A holding company is a business entity, such as a corporation, LLC, or limited partnership that owns enough stock in another company to exercise control over its management and direction. A holding company doesn't actually do anything, i.e., it doesn't produce goods or services. It simply exists to hold enough shares of another company to allow it to exercise control over that company.
There are multiple reasons for creating and using holding companies. Holding companies can be used to separate the personal owners of a company and the active operating business. This allows for tax-free dividends to flow to the holding company where it will be retained until the business owner chooses to use the money for personal use.
Holding companies are commonly used simply to hold investments such as marketable securities or a portfolio of rental properties.
Benefits of Using a Holding Company
Holding companies can provide asset protection as the holding company can retain the income separately from the active operating business which has more liability. For example, if the active operating business is sued, maintaining the additional assets properly in the holding company may mean creditors cannot “pierce the corporate veil” and gain access to those funds.
Holding companies are also frequently used in mergers and acquisitions and future sales of businesses.
Is an LLC Holding Company with S-Corp Status Right for You?
Operating as an S-Corp will allow you to limit the amount of employment taxes that you would have to pay on ordinary business income. The drawbacks of electing S-Corp status, however, is that it requires a lot of formalities, such as annual meetings of the board of directors, corporate minutes, separation of funds, etc. This is why many small business owners choose to operate as a single-member LLC that requires less formalities.
However, a single-member LLC has its own drawbacks. Since single-member LLCs are considered disregarded entities for tax purposes, the sole member of the LLC must report the entire business income on his personal tax return – subject to both income and employment taxes.
While the LLC may be the preferred choice of business structures for many because of its simplicity, an S-corporation has more tax advantages. However, by forming an LLC and electing S-Corp tax status, you can enjoy the simplicity of an LLC with the tax advantages of an S-Corp. An experienced business planning attorney and a tax accountant can better advise you on which business structure would best work for you.