Can an S Corporation Be a Shareholder in Another Corp?

Original post by Jeffrey Joyner of Demand Media

An S corporation is not a legal business form. Rather, it is a tax status the Internal Revenue Service confers on an existing corporation. A regular corporation pays corporate income tax, and then shareholders pay individual income tax on their distributions. With an S corporation, the company's earnings are not taxed; instead, they are "passed through" to the shareholders for taxation. To receive this favorable tax treatment, S corporations must comply with specific guidelines. As a general rule, an S corporation may own stock in another corporation, but such ownership may have consequences for the shareholders and the second corporation.

General Requirements for S Corporations

The business must be incorporated domestically, that is, it cannot be a foreign corporation. There may be no more than one stock class, and the number of shareholders may not exceed 100. Shareholders must be individuals, estates or qualified trusts. Non-resident aliens, corporations and partnerships are not acceptable shareholders in an S corporation.

S Corporation Owning Stock in an S Corporation

It is not accurate to state that an S corporation cannot own stock in another S corporation. It is possible, but it would violate the rules. This means that the company selling the stock to another S corporation would lose its status as an S corporation. The IRS would then tax the second company as a regular corporation, resulting in "double taxation" and higher taxes for the shareholders.

S Corporation Owning Stock in a C Corporation

An S corporation does not jeopardize its tax status if it purchases stock in a C corporation. If the S corporation shareholders are not active, material participants in the C corporation, dividends and profits from the sale of the C corporation's stock are typically subject to the passive-income limits. These limits apply to each individual shareholder, who must determine whether they "materially participated" in the C corporation's activities. The limitations on passive income do not apply to the S corporation.

S Corporation Owning Stock in an LLC

A limited liability company, or LLC, is a type of business entity that offers many of the benefits of a corporation, such as protecting shareholders from liability, with the "pass-through" taxation of a partnership. An S corporation may own stock in an LLC. However, some LLCs elect S corporation tax status. Selling stock to another S corporation may jeopardize the LLC's tax status with the IRS.

Resources

• The Money Alert: Sole Proprietorship vs. C Corporation vs. S Corporation vs. LLC
• NOLO: S Corporation Facts
• IRS.gov: Publication 542 -- Corporations

References

• Bankrate.com: Rules of an S Corporation
• U.S. Small Business Administration: S Corporation
• IRS.gov: S Corporations
• IRS.gov: Instructions for Form 1120S -- U.S. Income Tax Return for an S Corporation
• U. S. Small Business Administration: Limited Liability Company (LLC)

About the Author

Jeffrey Joyner has had numerous articles published on the Internet covering a wide range of topics. He studied electrical engineering after a tour of duty in the military, then became a freelance computer programmer for several years before settling on a career as a writer.