- Holding Company Taxes
Holding Company Taxes
Author: Real Estate Holding Company
A holding company (also referred to as a parent or umbrella company) is a company devised to house and manage one or more subsidiary companies. In addition to enhancing overall asset protection and privacy, holding companies can create unique financial benefits for business owners.
Through strategic asset allocation, company shareholders can utilize holding companies to consolidate taxes for multiple companies. A common strategy is to shift funds from the subsidiary companies to the holding companies in order to defer or minimize personal and business tax responsibilities.
If you own multiple businesses, you might find that consolidating your assets into one holding company is ultimately worth your time and resources.
What is the Purpose of a Holding Company?
When a business is thriving, it can use the creation of another business for many reasons. First, consider business revenue, where the owner lives, and the overall long-term goals for the business. When setting up a subsidiary company, the holding (parent) company, can better enter into a risky business with less risk. This is because even if the subsidiary fails, the parent company is not liable for the debt.
What Can You Fund a Holding Company With?
- Limited liability companies
- Private equity funds
- Brand names
- Hedge funds
- Publicly traded stocks
- Anything that has value
Holding Company Tax Implications
When you form a holding company, it can reduce and simplify taxes. This is because you will be able to file a consolidated filing, instead of one for each company. This reduction is not guaranteed, but the potential reduction comes from moving income to a lower tax bracket, due to income shifting.
The IRS has regulations in place that are used to deter parent and subsidiary companies from moving taxable income between one another. This began in 2013, with a law that an international subsidiary cannot use American intellectual property without paying the parent company.
This is because a parent company is not liable for subsidiary taxes, but it must be obvious that the two are operating independently. If the IRS sees that the two companies are truly one company, they will request back taxes.
How Holding Companies File Taxes
The IRS only requires one form to form a holding company, because the holding corporation files a single tax return for the entire group. This consolidated tax return includes all earnings, losses, and profits for each subsidiary company. It also requires it for the holding company to file the return.
Strategies to Defer Taxes
Holding company taxes are already complicated, and there are also multiple methods that allow for deferring taxes. One method is to have many shareholders. This can include making separate holding companies corresponding to every shareholder within the corporation. This delivers flexibility for shareholders, but also for the holding companies. In this case, the holding companies control each person’s dividend payments.
You can also defer taxes by utilizing retirement funds. In this case, you would need to use holding company assets similar to how you would use a pension, only using the assets upon retirement.
Create a Trust
Forming a trust, such as a family trust, is a great option to hold company shares. The holding company and your family can benefit because you will have the holding company receive dividends via beneficiary status. These dividends are usually tax-free, thus avoiding tax payments.
When you believe you might be sued, it is possible to essentially shield your funds from creditors. This is done by sending company profits to your holding company via dividends. If your business needs access to cash, the funds can be sent back. Overall though, it keeps your profits safe from the eyes of creditors without actually removing it from the business.
Another option is to split the income by having multiple people own your holding companies. This will divide the dividends, which in turn, decreases the taxes owed on them.
Benefits of a holding company
- Asset Protection: By placing operating companies and the assets they use in separate entities, it provides a liability shield. The debts of each subsidiary belong to that subsidiary, rather than to the parent company. If there is a creditor of the subsidiary, it cannot reach the assets of the holding company or another subsidiary.
- Reduce Risk: By being able to operate completely independently, holding companies have the option to reduce their risk by taking risks through the subsidiary. For example, should a subsidiary go into a risky industry, and fail, the holding company will not need to worry about its own assets.
- Flexibility: When forming a holding company, your business can own a variety of businesses in unrelated industries. It doesn’t matter if the owners and managers of the holding company don’t know about those businesses. Each subsidiary has its own management to run the day-to-day operations.
Holding Company Tax Disadvantages
Before electing to file consolidated returns, it’s crucial that the owners and interested parties of the holding company are fully aware of the implications and obligations involved. Once a motion is made to file a consolidated return in the form of a Schedule O, all subsequent tax filings must be made in this way. That also means that any future subsidiary companies acquired by the holding company must consolidate their earnings as well.
While special exemptions can be granted by the IRS, you’ll want to make sure that the benefits of filing a consolidated return outweigh the potential loses for future business ventures and acquisitions. If a subsidiary is in a significantly lower tax bracket, you might end up actually losing money when you consolidate tax filings to the holding company.
It’s also important that a holding company retain top-level legal and financial counsel to ensure all tax laws and guidelines are followed. For some business owners and investors, the complications of holding company taxes can seem daunting, making hiring expert counsel all the more worthwhile.
How to Create a Subsidiary
There are two methods of creating a subsidiary: formation and acquisition. If you’re looking to form a subsidiary, you can do so by registering the new company with the state in which it will operate. The actual formation process will vary some depending on which entity type you choose for the subsidiary, such as an LLC or corporation, as well as the particular regulations of the state in which you’re forming.
Another way to create a subsidiary is by acquiring an ownership stake in a company. This could be a wholly owned ownership stake (100%) or any controlling interest (greater than 50%). Note that however your subsidiary company is created, the company will require its own financial records separate from the controlling company and other subsidiaries. Additionally, the management style and autonomy of the subsidiary has flexibility and can be tailored to meet the needs of the specific company.
Consolidated Filings into One Schedule O
Depending on how many individual businesses you own, filing a tax return for each can be incredibly time consuming and costly. Even the most adept business owner will most likely require the assistance of a CPA or other paid preparer. The fees for filing individual tax returns alone can be enough to motivate you to find other options. That’s where consolidating your tax filings comes in.
Holding companies that own 80% or more stock in their subsidiary companies have the opportunity to consolidate their tax filings into a single Schedule O. A Schedule O, or Form 1120, is the form the IRS uses to report earnings between multiple “component members” of a corporate structure or holding company.
When filing a Schedule O, all organizations associated with the holding company must consolidate their tax information. That means you can’t pick and choose which subsidiary companies to include on your Schedule O. The consolidated return will list all the income and expenses of each subsidiary company and provide the holding company with its own single taxable income amount.
Income Shifting From ABCs to Holding Companies and More
There are various tax strategies to consider when filing consolidated returns, and not all of the strategies are devoid of risk.
You can note the detrimental effect that this type of loan has on any equity, considering that the market value had remained the same. To sum it up, do plenty of research before considering this type of loan. Take into consideration:
For example, a common strategy for business owners to defer taxes involves shifting some of the profits from subsidiary companies to the holding company. The goal with this strategy is to shift income subject to a higher tax bracket to a company subject to a lower tax bracket. Once the income is shifted, the holding company receives a tax break. This only works, however, if the holding company is actually in a lower tax bracket which usually means the company is located in another country. The IRS cracked down on income shifting in 2018 with new tax laws that keep a closer eye on companies that divert funds out of the U.S.
Another tax strategy involves sending profits from subsidiary companies to the holding company in the form of dividends. Depending on how the holding company treats these dividends, they can be considered exempt from taxation. To achieve this, many companies choose to create separate holding companies for each shareholder in the subsidiary companies. That allows more flexibility in dividend payments and keeps the holding companies in lower tax brackets.
When shareholders split their interests into individual holding companies, they also create the opportunity to establish trusts in which their dividends will be deposited. These trusts can be held by the owner, their spouse, or their children. Dividends are then distributed to the holding company as the beneficiary and are usually tax-free in most cases.
Get Help Filing Your Holding Company Taxes
Using a lawyer or business attorney can help you to file your holding company taxes. This is essential because there are many tax implications should you file incorrectly. If you file at the wrong time, then you will incur a penalty as a percentage of the amount of unpaid tax. If you do not use an attorney you may also miss out on different benefits and possible deductions. Overall, it is essential that you use a lawyer to get help filing your holding company taxes. This will help you to benefit from deductions, avoid penalties, and avoid overpaying on your taxes.
Forming a holding company is ultimately an excellent strategy to consolidate the earnings and liabilities of multiple subsidiary companies. The business structuring move allows companies to file consolidated tax statements and can even allow for deferred tax filings. However, the IRS keeps a close eye on these business arrangements, making expert legal and financial counsel a must.
Holding companies are business entities formed as either a corporation or limited liability company (LLC), formed to own other companies. Typically, a holding company doesn’t manufacture anything, they do not sell any products or services, or even conduct any other business operations. Instead, holding companies hold the controlling stock in other companies.
For example, one of the most well known holding companies is Berkshire Hathaway. This company is owned by Warren Buffett primarily, but Berkshire Hathaway owns GEICO, Dairy Queen and Fruit of the Loom, along with a variety of other businesses. Another example of a holding company is Alphabet. Alphabet owns Google, YouTube, Nest and a variety of other companies.
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