Can an S Corporation Be a Shareholder in Another Corp?

S corporations have a number of tax advantages over C corporations, but they also come with a number of restrictions. One of these is the ability to own shares in another corporation. An S corporation can own shares in a C corporation, but it cannot own shares in another S corporation, except in limited circumstances.

Many owners wonder what’s better, an S corporation or a C corporation. The chief advantage of an S corporation is that it combines the liability protections of a C corporation (the owners can’t be held personally liable for the company’s debts) with the tax advantages of a sole proprietorship. The S corporation pays no taxes itself; it simply passes its income through to the owners. Thus, the structure avoids the double taxation that results when a C corporation pays taxes on its income and its owners then pays taxes on their dividends.

However, there are limits on who can create and own an S corporation. In particular, an S corporation can have no more than 100 shareholders, and it can have only one class of stock. In general, all the shareholders must be individuals, and they cannot include nonresident aliens.

The IRS has made a few exceptions to these rules, though. For instance, while corporations and partnerships cannot be shareholders, an estate, trust or tax-exempt organization can own shares. Also, a group of family members can be treated as a single shareholder.

Suppose you want your S corporation to invest in another business, have a subsidiary or function as a holding company. (The difference between a holding company and a subsidiary company owner is that a holding company has no separate operations; it’s just a vehicle to own one or more subsidiaries, whereas a parent company may have its own functioning business.)

Unlike an S corporation, a C corporation has few restrictions on who can be a shareholder. As a result, an S corporation can be a shareholder in a C corporation. If you want your S corporation to own part of – or even all of – a C corporation, you won’t run into any problems.

But if you want your S corporation to have another S corporation as a subsidiary, the rules get more complicated.

As mentioned above, all of an S corporation’s shareholders must be individuals (or estates, trusts or tax-exempt organizations). Thus, in general, an S corporation doesn’t qualify to buy shares in another S corporation.

There's an exception, though, which is that an S corporation can completely own another S corporation as a “Qualified Subchapter S Subsidiary,” or QSub. To qualify, the parent S corporation must own 100% of the shares of the subsidiary S corporation, and it must elect QSub treatment from the IRS on Form 8869.

When this happens, the IRS treats the QSub as though it didn’t exist independently at all. All of the QSub’s income, expenses and so on are treated as belonging to the parent S corporation. However, you still get the advantage of liability protection – the parent S corporation is not liable for the debts of the QSub.