Should I Form a Holding Company for My Businesses?
Do You Own Multiple Businesses?
Many small business owners have several businesses. A young friend of mine named Carlos Mendosa has lots of ideas for online businesses, and he asked me if he should set them up as separate limited liability companies and then form a holding company as an overall entity. His reasoning for setting up separate businesses was to keep their liability separate, so one company would not be liable if another company was sued.
What is a Holding Company?
A holding company is a company (usually a corporation) that owns a controlling interest in another company, called a subsidiary. A holding company might be called an "umbrella" company or a parent company.
Sometimes a holding company is formed to hold assets (like equipment or buildings) and stock and the other company or companies are operating entities, which have no assets.
Do I Need a Holding Company?
If your multiple businesses are very small with few assets (like an online business, as Carlos has), it seems a lot of expense and trouble to form a holding company. Another possibility is to form just one company, Mendosa Enterprises LLC, and then to have several "projects" within that LLC. Carlos could then file a fictitious name ("doing business as") designation for each of these projects.
For example, Carlos has one online entity that sells used books, and another that provides websites to non-profit organizations and he has more ideas for other online businesses. Each one of these entities could have a fictitious name under Mendosa Enterprises LLC
Another alternative would be for Carlos to start a new LLC for each entity and not form a holding company. He would then have to keep the accounting for each one separate, and divide up some expenses (like his Internet service) among each company. Since he doesn't really have any assets except a computer, the holding company would not really have a purpose, except to bring together the accounting for income and expenses.
How Do I Start an LLC as a Holding Company?
Starting an LLC is a pretty painless task and one which you can do yourself. Go to the website of the Secretary of State for your state and find out the requirements for LLC's. Or read my article on how to form an LLC.
Are There Restrictions on LLC's Owning Corporations?
Different business legal entities can own each other, but there are restrictions. From the standpoint of a state, there are usually no restrictions - an LLC can own a C corporation, for example. The restrictions come with the IRS. If an LLC is an owner of a corporation, the LLC must elect C corporation tax status.
An LLC cannot own an S corporation because only individuals and certain trusts and estates can own this type of corporation.
A sole proprietorship is not eligible to own another company because it isn't registered with a state and its tax status is limited.
Is a Holding Company Liable for Acts of a Subsidiary?
In general, the liability of a holding company for its subsidiary's actions relates to the degree of control the holding company has over the operations of the subsidiary. In United States v. Bestfoods, in 1998, the Supreme Court held unanimously that a holding company isn't liable for acts of a subsidiary, if the parent didn't actively participate in, and have control over, the actions of the subsidiary, but there are exceptions.
The most important exception is if the corporate veil is pierced, meaning that the action was outside the normal activities of a business (fraud or negligence, for example). In this case, the owners of both the subsidiary and the holding company could be sued.
What about Taxes for Holding Companies?
The end result in each case above is going to be about the same. Each LLC (assuming he is the only member) files a Schedule C. The losses and gains of each LLC would be added up and placed on his personal tax return. Let's say his book sales entity had a net income this year of $5,000, and the website service had a loss of $2,000. He would record a net income of $3,000 on his tax return. So a loss by one entity can be used to offset a gain by another.
This is a complex issue, with liability and taxes to consider, and as a business grows, things will change. I urged Carlos to get an attorney and discuss his current situation, and future plans, to see which arrangement makes the most sense. If you are considering multiple entities, be sure you talk to an attorney and a CPA to make sure everything you do is according to the laws and will not have adverse tax consequences.