S Corporations Allowed to Own Subsidiaries

Regular “C” corporation subsidiary. S corporations may have 80%-or-more-owned C corporation subsidiaries. These C corporation subsidiaries may file a consolidated return with other C corporations with which they are affiliated. The S corporation cannot be included in this return, however.

Note as well that dividends received by the S corporation parent from its C corporation subsidiary are not treated as “passive investment income” to the extent they are attributable to the sub's active conduct of a trade or business. This can help the S corporation avoid the tax on passive income and the possible termination of its S corporation status that applies to S corporations with accumulated earnings and profits (i.e., earnings and profits from a year when it was not an S corporation).

Wholly-owned S corporation subsidiary. An S corporation cannot have a corporate shareholder. This rule ordinarily prevents subsidiaries from being treated as S corporations. However, this rule does not apply to qualified Subchapter S subsidiaries (QSSSs or Qsubs). Thus, an S corporation can have a QSub if it owns 100% of the subsidiary and makes the required election.

A QSub is not treated as a separate corporation. Instead, its assets, liabilities, income, deductions, etc. are all treated as those of the parent S corporation. The sub'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 the S corporation sub can be complex.

If an election is made to treat an existing corporation as a QSub, it will generally be treated as having liquidated in a tax-free subsidiary liquidation. The tax consequences of this move can be complex and must be thoroughly analyzed.