An “S” corporation can acquire and own the stock of a “C” corporation.  But having an “S” corporation own a “C” corporation may not make the most sense tax-wise.  The “C” corporation would be a taxable entity and would pay tax on all of its income at the “C” corporation rates.  The “C” corporation would then pay dividends to the “S” corporation.  This dividend would be received by the “S” corporation and taxed to the “S” corporation shareholders as a dividend (whether or not the shareholders received any cash).

This double tax phenomenon could be avoided by making a Qsub election.  Under IRC section 1361(b)(3), an “S” corporation can elect to treat a wholly-owned domestic corporation as a Qsub.  When the Qsub election is made, the subsidiary is deemed to have liquidated into the “S” corporation.  The Qsub is not treated as a separate corporation for federal income tax purposes.  All of the Qsub assets, liabilities, and items of income, deduction and credit are treated as items of the “S” corporation.  The Qsub continues its separate legal existence for state law liability purposes however.
If a Qsub election is made, the former “C” corporation (now a Qsub) does not pay tax on its income.  Rather, the Qsub income is included with the “S” corporation’s other income, allocated among the “S” corporation shareholders and taxed just once at the shareholder level.

Operating as an “S” corporation is often the way to go.  Putting separate divisions in subsidiaries is also a good move.  If you acquire a corporation and want to hold it as a subsidiary of your “S” corporation for liability reasons, consider making a Qsub election.  Give me a call or email if you have any questions about making a Qsub election at 937-223-1130 or Jsenney@pselaw.com.

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