Can an S Corp Own 100% of a C Corp? The Tax Strategy Most Advisors Get Wrong

Most business owners are told that entity structure is a matter of paperwork—but tax law sees every move you make, and the wrong setup could trigger double taxation, “control group” penalties, or lost deductions for years to come. Here’s why it matters in 2025, especially for California founders and high-income professionals looking for lasting tax leverage.

For the 2025 tax year, the oversight in how S Corps and C Corps interact isn’t just a technicality—it’s the difference between streamlined cash flow and an IRS audit trap. If you’re a business owner, high net worth investor, or real estate entrepreneur, understanding whether an S Corp can own 100% of a C Corp is critical to unlocking advanced tax strategies that can save (or cost) six figures over time.

Quick Answer

Yes, an S Corp is legally allowed to own 100% of a C Corp. There’s no restriction in the IRS code preventing an S Corporation from being the sole shareholder of a C Corporation. However, the reverse is strictly prohibited: a C Corp cannot own S Corp stock. The real question isn’t just “Can you?”—but “Should you?” and, “What are the tax traps if you do?”

The IRS code is clear: can an S Corp own 100 of a C Corp? Yes—there’s no restriction under IRC §1361(b). But remember, the S Corp doesn’t get “special” treatment on dividends. When profits flow back up, the IRS taxes them as ordinary income on the S Corp’s K-1, not as qualified dividends. That difference alone can raise your effective rate by 10–15 points.

Why Would an S Corp Own a C Corp?

Let’s get specific. One common scenario: a service business runs as an S Corp, but the founders want a subsidiary that shields certain activities—like real estate or risky IP licensing—from pass-through income. They set up a C Corp, 100% owned by the S Corp. This appears straightforward but creates powerful planning (and pitfall) opportunities.

• Liability Segregation: Isolate risk (e.g., a C Corp manages property while the S Corp operates the core consultancy)
• Qualified Small Business Stock (QSBS): Use the C Corp for activities that could unlock the IRC Section 1202 capital gains exclusion
• Employment Tax Arbitrage: C Corp can provide benefits (health, retirement, etc.) not available to S Corp shareholders in some cases

Example: Tanya, a California S Corp owner (net profit $900K), launches a C Corp subsidiary to handle a new SaaS app she plans to sell in 5 years. Her CPA touts “tax savings” from this move, but the strategy only works with precise earnings allocations and bulletproof compliance.

The Real-World Tax Implications—and When This Structure Goes Off the Rails

This isn’t just a flowchart. When an S Corp owns a C Corp, the C Corp is taxed at the entity level (currently 21% federal, plus 8.84% for California—even if the owner is in a lower bracket). Any after-tax profits distributed to the S Corp generate dividend income to the S Corp, which is then passed to S shareholders—potentially taxed again. That’s classic double taxation, and it catches even savvy business owners off guard.

A big trap when evaluating can an S Corp own 100 of a C Corp is assuming this setup avoids double tax. In practice, the C Corp still pays its 21% federal (plus 8.84% CA) corporate tax, and any distributions up to the S Corp are taxed again as ordinary income. The IRS has litigated cases where owners tried to reclassify distributions—courts consistently side with double taxation treatment.

Here’s the real trap: those dividends flowing up to the S Corp are not “qualified dividends” (because the S Corp is not an individual)—they become ordinary income on the S Corp’s K-1s. That can mean a 25–45% combined effective tax rate (plus 3.8% net investment income tax for high-income earners) before you see a dollar in your personal bank account.

• Numerical Example: The C Corp makes $500,000 pre-tax profit. It pays $150,200 in tax ($105,000 federal, $44,200 CA). After-tax: $349,800. Distributed to the S Corp, this is taxed again at the shareholder level. If the S Corp shareholders’ combined bracket is 37%, they may lose another $129,426—leaving just $220,374. That’s an effective 56% tax.

Are There Advantages?

The main upside is not day-to-day tax savings, but risk siloing and, potentially, access to C Corp-benefit strategies (e.g., health reimbursement arrangements).

When analyzing can an S Corp own 100 of a C Corp, remember that retained earnings inside the C Corp don’t flow up automatically. If the C Corp hoards cash without business justification, the IRS can apply the Accumulated Earnings Tax (IRC §531) at 20%. That means your “subsidiary piggy bank” could trigger an extra layer of tax if not paired with clear reinvestment plans.

Pro Tip: Don’t chase this setup for generic “tax savings”—use it when there’s a structural or risk reason you must wall off business assets or operations.

What the IRS Really Looks for—“Control Group” Surprises

The IRS isn’t just watching entity layers for fun. When an S Corp owns a C Corp, the two may be deemed a “controlled group” under IRC Section 414. This can trigger unexpected retirement plan aggregation, benefit discrimination testing, and FICA tax traps.

• Controlled Group: If the S and C are part of a parent-subsidiary controlled group, the IRS may require combining employee counts when determining 401(k) plan limits, ACA compliance, or certain tax credit eligibility.
• Attribution Rules: Compensation paid across entities may be aggregated for reasonable compensation analysis—a sleeper audit risk for high-salary owners.

This means your “separate” entities may suddenly have to act as one for compliance purposes—a surprise penalty if your advisors aren’t coordinating.

From a compliance angle, the question isn’t just can an S Corp own 100 of a C Corp, but how the IRS applies “controlled group” rules. Under IRC §414, the S and C may be aggregated for retirement plans, ACA, or payroll testing. If you ignore this, you could blow up 401(k) limits or trigger benefit discrimination penalties—issues most CPAs never flag until after an audit.

For a deeper dive on California S Corp strategies and why most CPAs overlook double-taxation risks in these structures, see our comprehensive S Corp tax guide for 2025.

KDA Case Study: S Corp Owner Dodges a $70,000 Tax Trap Using C Corp Subsidiary Structure

Persona: California-based marketing founder, age 44, S Corp with $1.1M net annual profit, newly acquired software intellectual property (IP).

Problem: Client wanted to keep IP and operational business separate for legal protection—and assumed putting the IP into a new C Corp owned by the S Corp would “save taxes.” Attorney set up both entities, but the CPA didn’t flag double-taxation risks from dividends flowing back to the S Corp.

Strategy: KDA restructured the subsidiary so the C Corp retained its profits for R&D reinvestment and delayed distributions for five years. Meanwhile, the S Corp paid reasonable salaries and kept the main business flow clean. On exit, partial liquidation allowed use of IRC Section 1202 to shelter $5M in gains from federal tax, as the C Corp had qualified as “small business stock.”

ROI: Client paid KDA $5,900. Net first-year tax savings from immediate dividend deferral: $28,500. Projected capital gains exclusion in five years: $1,120,000. Total ROI: 191x first-year, higher on exit.

Common Mistake That Triggers IRS Penalties

Red Flag Alert: Many S Corp owners assume any distributions from a wholly-owned C Corp will flow “tax-free” into the S Corp. Not true. Dividends up the chain do not become non-taxable simply because the recipient is a pass-through entity. The IRS treats them as ordinary income to the S Corp and then passes them to the shareholders’ K-1, potentially triggering “double tax.”

Another error: Failing to adjust for “control group” rules (IRC 414). Paying yourself across both entities—or running a benefit plan in both—without coordination can trigger ACA penalties, retirement plan audit, or lose advantageous credits like the Employee Retention Credit retroactively.

Fix: Always run both entities’ payroll, benefits, and retirement plans in lockstep. If you’re S Corp owner and officer of C, disclose on Form 1120 and Form 1120S schedules. Cross-check compliance before any major salary, bonus, or benefit decisions.

Getting Risk vs. Reward Right in 2025 (and When This Structure Makes Sense)

The right reason for an S Corp to own 100% of a C Corp is rarely “tax savings” alone. The strongest justifications:

• Legal liability firewall between business lines (e.g., separating active ops from riskier new ventures or IP)
• Eligible for Section 1202 QSBS exclusion if C Corp meets 5-year holding/current requirements
• Compliant split of benefits, where employee plans in the C Corp offer additional protected benefits unavailable in S

Trap to avoid: Don’t transfer ordinary business profits into a C Corp just for lower entity-level tax—you’ll almost always pay more in the long run if distributions come back to the S Corp or owners. Use this structure for risk compartmentalization, not as a pass-through backdoor.

Frequently Asked Questions

Can I Avoid Double Tax by Only Paying Salary?

No. If the C Corp pays out salary to the S Corp (as an employee), then payroll tax applies. If it pays dividends, the double tax applies. There’s no free lunch on C-to-S payments.

Will S Corp Ownership of C Corp Let Me Use QSBS Tax-Free?

Potentially, yes. For true “startup” operations, retaining C Corp profits and holding shares for five years could grant S Corp shareholders access to the Section 1202 exclusion (see IRS Pub 550). But get legal and tax review before executing.

Will This Structure Trigger an Audit?

Only if you treat intercompany loans, compensation, or distributions without arms-length documentation—or ignore control group rules. Maintain full paper trails and annual entity agreements to minimize risk.

Pro Tip

Use affiliated C Corps to wall off liability, but have a written “cash flow policy” between entities. This should lay out the rationale for cash transfers, dividend timing, and compensation. If you’re not ready to make it part of your annual entity meeting, you’re not ready for the complexity. For owner-operators with diverse interests, this is what separates IRS-proof structures from audit fodder.

Bottom Line: When to Use S Corp-Owned C Corps for Tax Strategy

Don’t pursue this structure for vague “tax savings”—pursue it for legal or investment goals where the complexity is justified. The proper use is for business owners running multiple ventures, high net worth individuals wanting to shelter unique asset classes, and real estate investors requiring airtight liability segregation. Make sure your entity chart, capital flows, and employee plans are coordinated every year. Tie all decisions back to official IRS S Corp rules.

Ready to Structure for Serious Savings—and Stay Audit-Proof?

If you’re considering an S Corp/C Corp combo or have one in place, don’t hope your current CPA “just handles it.” Book your custom tax structure session and see what a $70,000 fix (or a $1M mistake) looks like before the IRS does. Click here to book your consultation now.