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George Saenz, the Tax Talk columnistRules of an S corporation

Dear Tax Talk,
Two questions. Without jeopardizing S Corp status:

  1. Can an S corporation own less than 100 percent of an LLC?
  2. Can an S corporation be a part-owner in a commercial real estate building?
    -- Mike

Dear Mike:

An S corporation is structured so that its income is taxed to the shareholders. There are restrictions on who can own an S corporation. There are generally no restrictions on what an S corporation can own. Hence an S corporation can own less than 100 percent of a limited liability company. This is true even if the LLC has elected to be taxed as a corporation instead of a partnership. However, an LLC cannot own stock in an S corporation, and neither can another S corporation or conventional corporation own stock of the S corporation.

An S corporation can own a commercial real estate building whether in part or in whole. However, certain S corporations that own rental real estate can run into a tax problem.
An S corporation that has accumulated earnings from a period when it was not an S corporation may have to pay a corporate level tax on its passive income.
Accumulated earnings are corporate profits (from when the corporation was not an S corporation) that have not been paid out to the shareholders as dividends (hence incurring a second level of tax).

Passive income would include rental income from commercial real estate. If passive income exceeds more than 25 percent of the company's gross receipts for the year when it has accumulated earnings, the passive income can be taxed at 35 percent. In addition, the S corporation election will terminate after three years of being subject to the passive income tax.

If the S corporation was always an S corporation, this is not a concern.

To ask a question on Tax Talk, go to the "Ask the Experts" page, and select "taxes" as the topic.'s corrections policy -- Posted: Aug. 9, 2006
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