Protect Your S Corporation with an LLC

Protect Your Shares. In our last blog, we showed how to Protect your Corporation with an LLC if you operate your business as a regular C corporation. One of these methods is to have an LLC own all of your shares in your C Corporation; such LLCs can have more than one member. You benefit from this because there is no real protection against a creditor getting a court order to seize your shares in a Corporation. In contrast, your membership interest in certain LLCs in Virginia, Delaware and some other states and countries should be protected against court seizure and sale.

S Corporation. The S Corporation is designed for the small business where the owners want to avoid the double tax of the C Corporation. Under normal circumstances, an S Corporation pays no tax. Instead, all of the income and most of the deductions usually flow though to the owners of the S Corporation. This means an annual savings of 15% or more of federal taxes on each dollar earned.

Real People Are Owners. The S Corporation comes with a lot of restrictions. The government does not want large corporations to use S Corporations to avoid paying corporate taxes. This means that the shares in S Corporations can only be owned by a human being or certain trusts for human beings. Shares in S Corporations can not be owned by C Corporations or partnerships or by many LLCs. So how can we use an LLC to protect your S Corporation stock?

Vanishing LLCs. Current tax regulations allow you to “check the box” as to whether you want your new business to be taxed under the partnership or the corporate rules. A partnership means there are two or more partners. You can not have a partnership with only one owner. You can have a Corporation and also an LLC with only one owner. IRS regulations say that where you have only one owner, called a single member LLC, the “LLC” is a “disregarded entity” for tax purposes. This means that as far as the tax man is concerned, the single member LLC does not exist for tax purposes even though it exists as a legal entity under state law.

Single Member LLC. Well then, could you have a single member LLC own the shares in an S Corporation, have the LLC disregarded, and treat the human being who owns 100% of the LLC shares as a human being that owns the S shares? The IRS has said yes in several private letter rulings. A private letter ruling is where someone writes to the IRS for a ruling on their situation. The ruling protects the persons who got the IRS blessing, but no one else. However, this has been a consistent position in several of these rulings and the logic of this is very sound. So check with your tax advisor, but one way you could increase the protections of your shares in your S Corporation is to have them owned by a single member LLC. One letter ruling even approved of a limited partnership owning S shares where the general partner was a single member LLC owned by X and X was the only limited partner. For tax purposes, the limited partnership was ignored, but should be treated as a limited partnership under state law.

Cautions. Single member LLCs may offer less protection than multimember LLCs. Also, if you forget and bring in another person (who is not a spouse) as a member of the LLC, you will immediately blow your S election because now a real partnership owns the S Corporation.

IRS Circular 230 Disclosure.

IRS rules impose requirements concerning any written federal tax advice from attorneys. To ensure compliance with those rules, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under federal tax laws, specifically including the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.