Should I Form a Holding Company for My Businesses?
Do You Own Multiple Businesses?
Many small business owners have several businesses. If you are in that situation, you may want to consider setting up a holding company as an overall entity. The reason for doing that would be to keep the liability of the businesses separate, and manage them together.
What is a Holding Company?
A holding company is a company (usually a corporation) that owns a controlling interest in one or more companies, called subsidiaries. A holding company might be called an "umbrella" company or a parent company. The holding company doesn't do anything except manage the companies under its umbrella.
A holding company can own subsidiary companies that hold:
- Shares of stock in a corporation
- Securities, like stocks, bonds, and mutual funds
- Intangible assets like patents and copyrights
- Real estate
- Vehicles or equipment
- In other words, anything that has value
Each type of asset could be set up as a separate business. For example, you could form one business to hold real estate, and another to hold a fleet of delivery vehicles.
What are the Types of Holding Companies?
A holding company holds part of another company's stock.
A parent holding company owns enough stock (usually 51%) to control election to the board of directors.
A holding company is considered a personal holding company (PHC) under IRS rules if it meets two tests:
- An Income Test: At least 60% of the company's adjusted ordinary gross income for the tax year is from dividends, rent, interest, and royalties
- A Stock Ownership Test: If five or fewer individuals own a majority of the company's stock at some point during the latter half of the tax year
A PHC may be subject to a special PHC tax if at least 60% of its adjusted ordinary gross income for the tax year is PhC income. Schedule PH for the corporate tax return is used to determine if this tax must be paid.
Do I Need a Holding Company?
If your multiple businesses are very small with few assets (like an online business), it seems a lot of expense and trouble to form a holding company. Another possibility is to form just one company and then to have several "projects" within that LLC. You could then file a fictitious name ("doing business as") designation for each of these projects.
The advantage of a holding company over separate companies is that losses in one company can be used to offset profits in another, while still keeping the liabilities separate.
How Do I Start a Holding Company?
Before you start a holding company, you'll have to decide what type of company legal structure you want. The two most common types of companies are LLCs and corporations. Starting a holding company as an LLC or a corporation is a fairly painless task, but you should get the help of an attorney to make sure you do it correctly.
As you set up your holding company, you will need to find a board of directors to manage the holding company and oversee the subsidiaries. These people should be familiar with the holding company concept.
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 from 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.
This article on Who Can Own a Business has more detailed information on what kinds of companies or individuals can own businesses.
Is a Holding Company Liable for Acts of a Subsidiary?
In general, the liability of a holding company for one 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, and state laws govern these issues.
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.
More important, if you set up the individual companies within your holding company correctly, the liability for debts won't affect all the others. For example, if one subsidiary is set up to own real estate, and it goes bankrupt, the other companies should not be affected by the bankruptcy.
What about Taxes for Holding Companies?
The individual business entities each file their own tax report and the reports. Each business files a tax return, and the losses and gains of each business are added up and placed on the holding company's tax return. So a loss by one entity can be used to offset a profit by another on the holding company's tax return.
This is a complex issue, with liability and taxes to consider. Before you form a holding company, talk to an attorney and a CPA who are familiar with the laws and accounting for holding companies. Discuss your current situation and future plans to make sure everything you do is according to all federal and state laws and regulations