S-Corp Holding Company


Holding Companies

If you are wondering if your S-corporation can own an LLC, the answer is Yes. The owners of an LLC, called members, can be either individuals or legal entities, such as S-corporations, C-corporations, trusts, and even other LLCs.

One of the ways in which an S-corporation can own an LLC is as a holding company. But, why choose to act as a holding company and what are the benefits of doing so? Read further to find out.

What is an S-Corporation?

One An S-corporation is not a formal business structure, it is a tax classification. Both an LLC and a corporation can choose to be taxed as an S-corporation.

To become an S-corporation, the organization must meet the following restrictions:

  • Have no more than 1000 shareholders
  • The shareholders must be U.S. citizen or permanent legal residents
  • The shareholders must be private individuals (not LLCs, other corporations, or certain types of trusts)
  • The S-corporation can only issue one class of stock

The Benefit of S-Corporation Status

In LLC terms, a member is an owner. LLC members are not employees. In fact, LLC members cannot be employees. In tax terms, this means that the LLC members are not paid a salary. Instead, LLC members are paid in what is known as distributions.

When an LLC chooses to be taxed as an S-corporation, it allows members to be paid a salary as well as a distribution. This is important because salaries and distribution in an S-corporation are taxed differently.

If you have a single-member LLC, you are taxed by default as a disregarded entity. This means that money passes through the LLC to you. Remember, you cannot be an employee, so you must receive income in the form of a distribution.

That distribution is subject to both employment tax and income tax. A multi-member LLC that is taxed as a partnership by default works the same way.

However, if an LLC chooses to be taxed an S-corporation, then the members can be employees. The income generated will then be paid to the members both as a salary and a distribution.

The salary will be subject to both employment tax and income tax, but the distribution will only be subject to income tax. This is how S-corporation status can potentially save your business money.

Employment tax is usually around 15%. But, an S-corporation allows you to limit that employment tax to a reasonable salary amount, while the rest of your income, paid in the form of a distribution, is only subject to income tax.

Thus, the main benefit of an S-corporation is that it saves you from having to pay self-employment tax on distributions.

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. It doesn't produce goods or services. It simply exists either to hold shares of another company or investments, such as a portfolio of marketable securities.

The first common use of a holding is where it is interposed between the owner of a company and the active operating business.

This allows the business’s profits to flow up tax-free to the owner via dividends and to be retained in the holding company until the business owner needs the money personally.

The second use of a holding company is simply to hold investments. Those investments can be marketable securities or even a portfolio of rental properties.

Again, income generated from these investments will flow up and be held in the holding company until needed, then ultimately be paid up to the owner as a dividend.

The Benefits of Using a Holding Company

There are several benefits to using a holding company. The first benefit is asset protection. The legal structure by which holds your assets is critically important. Using a holding company for various assets means that they may not be accessible to the creditors of the operating company.

Another reason to use a holding company is the timing of compensation. A holding company can effectively allow you to retain income inside the holding company until a later point in time when you are ready to receive the income.

It may also be a benefit to hold certain assets inside of a holding company for federal estate tax planning purposes. Any assets you own in your own name when you die may be subject to federal estate tax, depending on the value of your estate.

It may also be a benefit to hold certain assets inside of a holding company for federal estate tax planning purposes. Any assets you own in your own name when you die may be subject to federal estate tax, depending on the value of your estate.

There are also a variety of other reasons why someone might use a holding company, such as for mergers and acquisitions activities and the future sale of the business.

Why You Should Form A Holding Company as an LLC and Elect S-Corporation Taxation?

As explained above, operating as an S-corporation will allow you to limit the amount of employment taxes that you would have to pay on ordinary business income.

The problem with an S-corporation, 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 a lot of small business owners choose to operate as a single-member LLC, which requires very few formalities.

On the other hand, the problem with a single-member LLC is that it is a disregarded entity for tax purposes. This means that the sole member reports all of the business’s income on his or her personal tax return, where it may be subject to both income and employment taxes.

While the LLC is the preferred choice of business structures for many because of its simplicity, an S-corporation is more advantages in terms of tax advantages.

So, the solution to this dilemma is to form an LLC under state law and then elect to have it taxed as an S-corporation instead of a disregarded entity for federal income tax purposes.

By doing so, you get the benefits of both an LLC and an S-corporation. In other words, you get the simplicity of an LLC with the tax advantages of an S-corporation.

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