Do I Need a Holding Company?
What is a holding company, and do you need one?
If your company owns several businesses, you may want to consider a corporate structure where a separate holding company controls the individual businesses. There are many benefits to this type of arrangement including 1) keeping the liability of each business separate from the others and 2) tax benefits that allow you to offset the losses of one business with the profits of another business.
In this article, we will discuss:
- What a holding company is and how it can be structured,
- How a parent holding company works,
- The tax benefits of a holding company, and
- The liability protection that a holding company can provide to your businesses.
What is a Holding Company?
A holding company is a business entity that does not conduct any business. Instead, its purpose is to “hold” subsidiary companies by either owning the subsidiaries outright or by holding a controlling share of stock in the subsidiaries.
The subsidiaries can be “operating companies,” that conduct business by, for example, manufacturing, selling, or distributing products or by providing services, or the subsidiaries can be set up to hold property that is used by the operating companies like:
- Real estate,
- Intellectual property,
- Vehicles, or
- Machinery and equipment.
Each subsidiary manages its day-to day operations, while the parent holding company can oversee the subsidiaries’ daily operations and make major policy decisions like mergers and acquisitions (but not day-to-day operations if you want to preserve liability protections).
What is a Parent Holding Company?
A parent holding company holds enough stock in the subsidiary companies to control the subsidiary’s board of directors, and it might also be referred to as an “umbrella company” or a “parent company.” Its sole purpose is to manage the subsidiary companies.
Should a Holding Company be a Corporation or an LLC?
A holding company can be either a C corporation or an LLC, but, if the holding is set up as an LLC and its subsidiary is a C corporation, the IRS will require the holding company to file its tax returns as if it were a C corp.
There may be other considerations based on your corporate structure – before forming a holding company, you should consult with your corporate attorney and a CPA.
What are the Benefits of a Holding Company?
Instead of a holding company, you could set up a single corporation or LLC that contains all your business endeavors and use a DBA (“doing business as”) for each separate business that you control. That’s a simpler corporate structure that may be appropriate for many small businesses.
On the other hand, there are benefits to splitting your business operations into separate corporations or LLCs with a controlling parent company – including financial benefits from liability protection and tax benefits.
What are the Tax Benefits of a Holding Company?
There are tax benefits to having a holding company that oversees the operations of multiple subsidiaries.
For example, each subsidiary will prepare its own taxes – some subsidiaries may be doing well (and be required to pay taxes) while others may report a loss. The losses and gains of each subsidiary are then reported on the holding company’s tax return, and the losses of one subsidiary can be used to offset the gains of another subsidiary, reducing the taxes owed.
Another example is that a subsidiary that is owned by the holding company can be treated as a “disregarded entity” for purposes of the IRS. You don’t need to file separate tax returns for them, but you still have the benefits of offsetting your tax debt with the subsidiary’s losses, and you can still maintain the liability protections of multiple corporations.
Does a Holding Company Provide Liability Protection?
A corporate structure that includes a holding company may be essential to some businesses for risk management.
Some operations may have more risk than others – risk of failing or risk of litigation. You can protect your business’s assets by dividing the company into 1) a holding company and 2) multiple subsidiaries that:
- Conduct business operations,
- Hold the business’s trademarks, patents, and intellectual property,
- Hold the business’s equipment or vehicle fleet, and
- Conduct day-to-day operations like manufacturing, distribution, or sales.
Liability of the Holding Company
Although there are exceptions, the holding company is generally not liable for the actions of its subsidiaries, and the holding company ordinarily cannot be held responsible for the subsidiaries’ debts. This depends on how much control the holding company has over the subsidiary’s operations and whether the holding company participates in the subsidiary’s actions.
Creditors or plaintiffs in a lawsuit can “pierce the corporate veil,” however, and hold shareholders (including the holding company) liable when the company was used to perpetrate a fraud. To pierce the corporate veil in Texas, the creditor must show that the corporation is:
- The “alter ego” of the parent company,
- Used to “avoid legal limitations upon natural persons or corporations,” or
- A sham that is used to perpetrate a fraud.
And a creditor must prove “actual fraud” which includes:
- “A party conceals or fails to disclose a material fact within the knowledge of that party,”
- “The party knows that the other party is ignorant of the fact and does not have an equal opportunity to discover the truth,”
- “The party intends the other party to take some action by concealing or failing to disclose the fact,” and
- “The other party suffers injury as a result of acting without knowledge of the undisclosed fact.”
Can a holding company be held liable for the actions and debts of its subsidiaries? Yes, sometimes. But, when the companies are structured correctly and when they follow the rules, there is substantial protection.
Liability of Subsidiaries
Each subsidiary is also protected from the other subsidiaries’ debts and liabilities. For example, if subsidiary A is unable to fulfill a contract and a creditor obtains a judgement against subsidiary A, the creditor cannot execute that judgment on subsidiary B which is a separate corporate entity.
This means that, if the corporations are set up correctly and if they follow the rules, your assets like machinery, intellectual property, and real estate are protected from liability.
Or, if subsidiary A fails and is forced to file bankruptcy, creditors cannot make claims against subsidiaries B, C, or D, because they are separate corporations.
Please feel free to contact one of our Murray Lobb attorneys to obtain our legal advice regarding your business’s corporate structure, including whether a parent company with subsidiaries could protect your company’s assets. We also remain available to help you with all your general business, corporate, and estate planning needs.