When choosing an entity for your business, keep in mind there are opportunities to use an S corporation to hold stock in other corporations, but not the stock of other S corporations. If any corporation acquires the S corporation’s stock, that S corporation becomes a C corporation, which is generally detrimental. The truth is that taxpayers with S corporations have a great deal of flexibility in structuring their corporate holdings. This flexibility allows an S corporation to hold C corporation subsidiaries and qualified Subchapter S subsidiaries, as explained below.
Regular C Corporation Subsidiaries
S corporations can own up to 100% of the stock in another corporation. A corporation that owns more than 50% of the stock of another corporation has the right to control that corporation. Ownership of 80% or more of the stock of another corporation establishes an affiliated group relationship. Thus, S corporations may have 80%-or-more-owned regular C corporation subsidiaries. These C corporation subsidiaries are allowed to file a consolidated return with any other C corporations they are affiliated with. However, the parent S corporation cannot be included in this return. In summary, S corporations can own and operate one or more chains of subsidiary C corporations or brother/sister C corporations, but cannot join in the filing of a consolidated return.
Qualified Subchapter S Subsidiaries
Because an S corporation cannot have a corporate shareholder, subsidiary corporations cannot be treated as S corporations. However, an S corporation can have one or more qualified Subchapter S subsidiaries (QSubs) if it owns 100% of the subsidiary corporation and makes the required election.
A QSub is ignored for federal tax purposes, and its operations are reported as part of the parent S corporation’s income tax return. In addition to the efficiency of eliminating multiple tax returns, the shareholders gain the ability to offset losses from one or more QSub entities against the income of other members of the parent S corporation/QSub group. Furthermore, QSubs generally limit the parent company’s legal liability. The use of multiple corporate entities helps prevent problems in one business or location from affecting others.
A QSub is not treated as a separate corporation. Instead, its assets, liabilities, income, deductions, etc., are treated as those of the parent S corporation. The QSub’s accumulated earnings and profits, passive investment income, and built-in gains are also treated as those of the parent. Other tax consequences relating to QSubs can be complex.
Please contact Martini, Iosue & Akpovi by phone at (818) 789-1179 if you have questions or want more information.