3 Advantages of a holding company—and how to structure your business

By Nellie Canopy

A holding company is a legal entity (usually a limited liability company or C corporation) that owns or has a controlling interest in one or more companies (called “subsidiaries”). Other terms for holding company include “parent company” and “umbrella company.” Regardless of the wording, a holding company helps protect its individual subsidiaries’ assets and limit liability risks across all subsidiaries.

In addition to owning other businesses, a holding company may own other assets, such as:

  • Stock and securities
  • Patent
  • Trade marks
  • Copyrights
  • real estate

Why form a holding company, what is the relationship between a holding company and its subsidiaries, and what type of entity is best for a holding company? We will talk about these issues in this article. I also encourage business owners to seek legal and tax guidance from an attorney and accountant to help them make informed decisions about many business structures.

The relationship between the holding company and its affiliates

Each subsidiary under the holding company is structured as its own separate company. Therefore, if subsidiaries are established as corporations or limited liability companies (LLCs), each must file articles of incorporation or articles of incorporation with the state, have its own bylaws or LLC employment agreement, have its own bank accounts, and operate its business. Maintain its own payroll, and its own financial records.

Typically, a holding company serves as the owner and manager of its subsidiaries, but has no direct operational involvement with them. Each has its own management to run its day-to-day operations, the company’s management owns the assets and oversees the big-picture policies and decisions of the subsidiaries. Generally, the activities of a subsidiary do not affect the activities of other branches of a company.

Benefits of a holding company

Reduce liability

When entrepreneurs own multiple businesses, they form a sole proprietorship to limit liability risks. Each branch is protected from the legal claims and liabilities of the other branches.

Likewise, a joint stock company cannot be held liable for the legal or financial problems of its subsidiaries unless it actively participates in its branch offices or guarantees the branch’s debts. However, if the holding company or its affiliates pierce the corporate veil – for example, if they commit fraud, are negligent in some way, or if the entities do not follow state compliance requirements – they may be at legal or financial risk from the holding company and possibly the company’s owners.

Attract investors

Funding and development benefits are also possible. Because subsidiaries under a holding company are their own legal entities and are protected from the liability of other subsidiaries, it may be easier to attract investors or partners if they are all structured as one entity with multiple divisions.

And, if the joint stock company needs financing, it may be able to get a loan at a lower interest rate than its individual companies because of its stronger financial position.

Increase tax efficiency

Generally, subsidiaries of a C corporation file their own tax returns and pay dividends to their corporation without creating a tax liability to the parent company if the dividends were paid to individuals. The stock company can either give the profits to its shareholders or reinvest them in other subsidiaries – choosing what suits their tax and growth goals.

Alternatively, profits, losses, and tax liabilities of subsidiaries that are treated as disregarded entities (eg, LLCs, partnerships) for tax purposes are reported on the parent company’s consolidated federal tax return.

Subsidiaries of a C corporation may be reported on a consolidated return if they file IRS Form 1122 (Consent and Consent to Include in Consolidated Income Tax Return).

If a holding company files a consolidated tax return, the profits of one or more subsidiaries may be offset by the losses of others. That helps to collectively lower the tax burden on the companies under the parent company.

Remember that while subsidiaries do not have to file their own federal tax returns when they are part of a joint stock company’s consolidated return, they must file their own at the state level. State tax laws vary, so it’s important to check the laws that apply to your state. For example, in California an LLC holding company (not taxed as an S-Corp) is required to file a separate Form 568 (Limited Liability Company Income Return) for each subsidiary LLC.

Additional articles from AllBusiness.com:

C Corporation or LLC as Holding Company?

There is a lot to consider when setting up multiple businesses under a holding company. First and foremost, what kind of entity is chosen for the parent company.

C Corporation

An AC corporation is a separate legal and tax-paying entity from its owners (shareholders). Therefore, it provides the benefit of personal liability protection because all the actions of the corporation are tied to the corporation and not to the owners. For entrepreneurs looking to grow their business, the C Corp structure allows them to raise capital by issuing or selling stock. Also, a C Corp has perpetual existence under state law, so a consolidated parent company can last indefinitely (until formally dissolved).

Basic steps to form and maintain a C Corporation

  • Name a registered agent
  • File articles of incorporation
  • Get an EIN
  • Appoint a board of directors
  • Approve bylaws
  • Apply for business license and permit
  • Open a commercial bank account
  • Hold board of directors meetings
  • Conduct shareholder meetings
  • Submit an annual report

Some of the potential disadvantages of forming a C Corporation as a holding company are more paperwork and more extensive compliance formalities to register the organization—such as adopting bylaws, holding board of directors meetings, holding shareholder meetings, filing annual reports, etc. Requirements for registering and maintaining a C corporation vary by state.

Then there is double taxation – income is taxed at the corporate level by the corporation and then paid to shareholders at the individual level.

Limited Liability Company

A limited liability company also protects its owners (known as “members”) from personal liability. Additionally, it does not have as extensive compliance requirements as a C corporation.

Basic steps to form and maintain an LLC

  • Name a registered agent
  • File the articles of organization
  • Get an EIN
  • Create an LLC employment agreement
  • Apply for business license and permit
  • Open a commercial bank account
  • Hold member meetings (if required by LLC operating agreement)

By default, the LLC is taxed as a disregarded entity, and all profits and losses pass through to the owners of the business. However, if it meets the IRS’s eligibility requirements, an S corporation or C corporation may choose tax treatment. Compliance requirements vary by state, but typically an LLC does not have to have an annual meeting or board of directors unless the operating agreement states otherwise.

Some of the drawbacks to operating as an LLC are that you cannot issue stock to raise capital and may not have as many tax deductions as a C corporation. Also, if an LLC’s operating agreement does not have perpetuity provisions, state law may force the LLC to dissolve if one or more members die or leave the company.

Moving existing LLCs or corporations under a holding company

If ownership of a C corporation is changed from individuals to a holding company, the procedures outlined in the corporation’s bylaws must be followed. If the joint stock company is a corporation, this may involve a stock exchange, whereby the shareholders exchange their shares in the operating company for shares in the corporation (the shareholders are assumed to be the same in the operating corporation and the holding corporation).

If you change ownership of an LLC from individuals to a holding company, the procedures outlined in the LLC Operating Agreement must be followed to make that change. Often this involves the creation or dissolution of an LLC purchase to change from individual(s) to holding company ownership.

Things get more complicated when it comes to being taxed as an S corporation versus an operating LLC. Shareholders of an S corporation can only be individuals, a qualified single member LLC, certain trust holdings, and certain exempt corporations. In other words, the shareholders of an S corporation cannot be a partnership or corporation unless they qualify for the QSub (qualified subchapter S subdivision) election. The QSub election essentially allows the QSub to be treated as a nondisciplined entity for federal income tax purposes and fall into a holding company that is either a partnership or a corporation.

Choosing the right business structure

Setting up multiple businesses can be complicated from a tax and legal perspective. It’s important to get guidance from experts to help you understand your options and how they will impact you and your companies.

About the author

Nellie Canop is a passionate entrepreneur, business professional, professional speaker, author and mother of four. She is the founder and CEO CorpNet.comTrusted resource and service provider for business incorporation, LLC filings and corporate compliance services in all 50 states.

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