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With a Parent/Child Structure, Which Company Should be Taxed Under Subchapter S?

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Question:

I’m trying to explain to my CPA how my Anonymous LLC parent/child structure works, and make sure my CPA understands it, especially how I can tax myself under S-Corp status.

If the Child LLC is disregarded, how to I pay myself S-Corp salary? It seems like the Parent LLC should be the S-Corp and doing the payroll, but it’s not in Florida where I live so there could be issues to deal with. I tried to explain this to my CPA, and it only caused confusion.

What’s the right way to handle this?

Answer:

When forming a parent/child LLC structure, you may want to elect for one of the LLCs to be taxed as a Subchapter S Corporation (for more on why you might consider such an election, read A S-Corporation May Help You Save a Lot in Taxes). If you decide to elect S-Corp tax treatment, the question becomes “which LLC”? The answer to that depends a lot on your circumstances, which means you really should consult with a tax professional to discuss your specific circumstances (a comprehensive evaluation is outside the scope of this knowledge base article — we try to keep these to under a 5-minute read).

One Circumstance that Influences S-Corp Tax Treatment: Status of Owners

One example that can influence “which LLC” includes limitations associated with the permissible owners of a S-Corp.

An S-Corporation (or “S-Corp”) cannot be owned by a partnership or another corporation – or an LLC taxed as either. Nor can an S-Corp be owned by “nonresident aliens” – a term used in the Internal Revenue Code to refer to non-citizens not permanently residing within the United States. An S-Corp (or an LLC taxed as one) can only be owned by individuals, LLC’s taxed as disregarded entities, certain trusts, and estates (and remember that LLC’s can only be taxed as disregarded entities if they have one owner or are owned by a husband-wife living in a community property state).

What does this mean for you, who wants to own a parent/child structure, and benefit by S-Corp tax treatment?

It means that if the Parent LLC has multiple owners, the Parent LLC must make the S-Corp election. This is, of course, contingent on every owner of the Parent LLC themselves being eligible S-Corp shareholders. The Child LLC – still the “operating company” and transacting business – would be treated as a “disregarded entity” for tax purposes, and the profits and losses of the Child LLC would pass through to the Parent LLC and included on the Parent LLC’s Form 1120-S (S-Corp Tax Return) each year.

Yes, under this scenario, it means the Parent LLC is paying the salaries and subjecting you to domestic state of the Parent LLC (this is one of the reasons we recommend Wyoming as the domestic state for the Parent LLC, when the Parent LLC is owned by multiple owners).

However, if the Parent LLC only has one owner, you could elect to make the S-Corp election for either the Parent or the Child LLC, where the non-electing LLC is treated as a disregarded entity.

Which should you choose?

That answer depends on how you ultimately plan to structure your business (or businesses) and how you’d like payroll handled across the board. For example, if you have multiple businesses (or Child LLCs) under a common Umbrella/Parent LLC, you may want the Child LLCs to make individual S-Corp elections so that the payroll is separated for each line of business. Alternatively, you may want to consolidate payroll under the Parent LLC. You may also have state-specific workers’ compensation, unemployment insurance, and other state-level tax requirements that might require you to choose the Child LLC as the entity to make the S-Corp election.

This can get complicated quickly, so it’s important to get a sense for what your options are and what unique issues you might be facing in such a decision. We highly recommend scheduling a tax attorney consultation to come up with a solution that’s tailored to your needs. We’re happy to converse with both you and your CPA in a conference call, to help you implement a tax structure your CPA understands and supports. Please note we charge extra for our tax attorney consult, and that it is not included in the base price of an Anonymous LLC or LLC Formation (the consult is an option, however, you can include in your purchase).

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2 comments

  • Hi Ian,

    Regarding ” Alternatively, you may want to consolidate payroll under the Parent LLC. ”

    How does this apply if the Parent LLC is for Anonymity as the Management company and the Child LLC is the Operating company and no funds or taxes are actually getting passed through the Parent/Management LLC?

    see the following article for this except:
    “In this scenario, the Anonymous LLC is a management company, not a holding company. As a management company, NO REVENUE passes through the Anonymous LLC at all. This means no taxes, profits or losses to worry about. All such concerns happen at the child level.”

    https://www.l4sb.com/knowledge-base/how-do-you-get-money-in-and-out-of-a-parent-child-anonymous-llc-setup/

    • Hi, Stacey —

      Thank you for your question. There may be some confusion with respect to how funds are supposed to move up and down the ownership chain. With an anonymous parent-child LLC structure, funds should move into the parent company if, for example, you’re looking to take an ownership draw/distribution of the profits made by the child company. You shouldn’t transfer them directly from the child company to yourself (with the exception being in the event you’re paid a salary directly by the child company — assuming that the child company is taxed as a corporation, which is the only valid way for you to receive W-2 income from your own company).

      All that said, with respect to payroll, we talk about “consolidating payroll under the Parent LLC” if you have multiple child LLCs under a common parent company and if those LLCs share employees. Consolidating under the parent company makes it so that you don’t have to have these people separately employed by multiple LLCs. That said, you cannot consolidate payroll under a parent company if the parent company is in a state other than the state in which you’re operating and employing people. For example, if you have a New Mexico parent company and a Texas child company, with all your employees based in Texas, you cannot have those folks employed by the New Mexico company. To do so would ultimately require you to qualify your New Mexico parent company as a foreign LLC in the state of Texas, negating all anonymity.

      In the rare situations where you have multiple child LLCs that share employees and you want to consolidate payroll under a common parent, the best approach is to form a mid-level LLC in the state you’re operating in. To reuse the example above: if you are based in Texas and have multiple Texas LLCs that share employees, you would have (i) an anonymous parent LLC in the State of New Mexico, (ii) a mid-level Texas LLC directly beneath it to serve as a local (within Texas) holding company, and (iii) the various operating LLCs beneath that mid-level Texas holding company. Your Texas-based employees would be employed by the mid-level Texas holding company, which would be fully qualified to do business in Texas without compromising your anonymity.

      I hope this helped to clarify the concepts. We’re always happy to discuss your situation in more detail through a Business Attorney Consultation. Thank you again for your question!

      All the best,

      Ian M. Alden

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