S corporations are a particular type of company under the Internal Revenue Code. There are some restrictions on who can own S corporation stock and what types of stock they can issue, but there are not restrictions on stock or funds that S corporations can own.
S Corporations are legally entitled to invest money in stocks or mutual funds as they see fit.
How S Corporations Work
For federal tax purposes, the Internal Revenue Code essentially defines two types of for-profit corporations, called S corporations and C corporations for the subchapters of the tax code in which they're explained. Most big companies are C corporations, and they file and pay taxes on their earnings separately from their shareholders.
S corporations, on the other hand, file an abbreviated tax return with the Internal Revenue Service called Form 1120s, but their shareholders claim the company's profits or losses on their own personal tax returns. This is sometimes considered advantageous, since it avoids a form of double taxation in which a corporation is taxed on its profits, then the shareholders are again taxed on receiving a dividend from the corporation.
S Corporation Restrictions
To become taxed as an S corporation, a corporation set up under its state laws must file a form with the IRS called Form 2553, in which all of the shareholders unanimously agree to choose S corporation status.
To be eligible, the corporation needs to have at most 100 shareholders, who must be individuals or certain kinds of estates or trusts. Certain family groups can be counted as one shareholder. Corporations, partnerships and limited liability companies generally can't own interests in S corporations, and certain types of financial institutions, insurance companies and other businesses aren't allowed to elect to be S corporations.
S corporations also can only have one class of stock, unlike C corporations which sometimes offer preferred stock or other special classes to investors, and they generally need to distribute their profits and losses equally among their shareholders according to how much stock each owns.
S Corporation Investments
The restrictions on S corporations mean that they're not going to be listed on the public stock exchanges or appear in the investments listed by a mutual fund. But there are no rules that say S corporations themselves can't buy stock in other corporations or invest in mutual funds. They're also allowed to own stakes in partnerships and limited liability companies.
When an S corporation generates income, losses, capital gains or capital losses from its investments, those are generally simply distributed and passed through to its investors to handle for tax purposes similar to any other activity by the S corporation.
- Speigel & Utrera, CPA; S Corporation Advantages and Disadvantages; Stephen L. Nelson, CPA, MBA
- IRS: About Form 1120S, U.S. Income Tax Return for an S Corporation
- IRS: S Corporations
- The Dual Tax Burden of S Corporations | Tax Foundation
- Presti and Naegele: Can an S Corporation Own an Interest in Another Business Entity?
- ThinkAdvisor: How Is a S Corporation, or Pass-Through Entity, Taxed?
Steven Melendez is an independent journalist with a background in technology and business. He has written for a variety of business publications including Fast Company, the Wall Street Journal, Innovation Leader and Ad Age. He was awarded the Knight Foundation scholarship to Northwestern University's Medill School of Journalism.