Recently, a client contacted me with a question: he – well, technically, his S-corporation -  was the member of a professional partnership that was dissolving. The partnership’s accountants were recommending that instead of a partnership – which leaves its non-corporate members exposed to general liability – it should form an S-Corporation.

And that’s a problem. Treasury Regulation 1.1361-1(b)(ii) specifically restricts S-Corporation ownership to an individual, and not all of the partnership’s partners are individuals. Some are S-Corporations. And as I mentioned, only an individual can own an S-Corporation’s shares – one S-Corporation cannot own shares in another S-Corporation (the only way this could possibly occur is a Q-Sub election (but see Treas. Reg. 1.1361-4 for the effect of that – generally, it means the parent S absorbs the sub-S)).

So what can be done? Well, if the parent level company’s goal is liability limitation, then there are two potential answers: an LLC or a standard, “C”, corporation. An S-Corporation can be a shareholder in either one of those entities*, and the top-level entity would have liability protection.

But…what happens if this is a professional partnership, say, doctors? They can’t form an LLC – it’s prohibited by California law (anyone with a state license must form a professional corporation instead). That leaves one alternative – the C corporation. An S-Corporation can be a shareholder in a C-corporation (heck, it can be more than ‘a’ shareholder – it can be the 100% shareholder), so the shareholders who were already S-corporations wouldn’t have to change their form, and the parent can get some liability protection.

Now, about the dissolution….well, that’s a different day.

* – for the purposes of this post, we assume a single member S-corporation. The strategy doesn’t work for multi-member S-corps.