Holding companies do not manufacture products, offer services, or conduct business. As implied by the name, their sole job is to hold onto the controlling stocks or membership interests in other businesses. They own subsidiary companies that sell products or services or manufacture products. The companies owned by a holding company are called operating companies. A subsidiary may hold equipment, intellectual property, real estate, vehicles, and other things of value that are used by operating companies. Holding companies may own 100 percent of a subsidiary or own just enough interest to control the subsidiary. This means that they have sufficient stock to guarantee that in a vote any decision would go their way.
Sometimes, they own 51 percent of the company. When there are multiple owners, the controlling interest may be a much lower percentage. For each subsidiary, there is management that controls the day-to-day operations. The management of the holding company controls the big picture of how subsidiaries are run. They make policy decisions, such as deciding when to dissolve or merge subsidiaries, and decisions affecting LLC managers and corporate directors. However, those who run the holding company do not get involved in the day-to-day decision-making.
Tax Implications of Holding Companies
Holding company tax can be complicated, but it offers several advantages. For example, with a holding company, you do not need to file unique tax returns for each subsidiary.
Holding companies may help shareholders save and defer tax on earnings. Subsidiaries are typically allowed to pay dividends to a holding company with no tax liability. Once a holding company receives cash, disbursements can be given to stockholders of the holding company and then be used to invest in other subsidiaries.
Consolidated Tax Returns
Holding companies that file merged tax returns can offset the loss of some of their subsidiaries against the profits of other subsidiaries. The result is a lower tax bill for all the subsidiaries as a group.
The dividend disbursement structure of holding companies allows them to reinvest collective amounts of dividends into stable, profitable investment vehicles without tax liability until shareholders opt to withdraw. It is of note that in the United States, holding companies must have a set percentage of a subsidiary company’s shares before being able to offer tax-free dividend transfers.
To minimize taxes for subsidiary companies, holding companies may assume some of the subsidiary’s income as their own. This may put the subsidiary in a lower tax bracket.
Since subsidiaries typically pay fewer taxes, this is a cost-effective method of relocating corporate income. This practice is often referred to as “skimming.” There are strict guidelines on how this practice can be performed. It should only be handled with the close supervision of an experienced financial advisor or business account.
Capital Gains Exemptions
When assets are bought and sold by a holding company, there exists the possibility of exemptions on capital gains from the sale of said asset. This is because the holding company doesn’t take part in the operations of the company it owns. Therefore, claiming capital gains under this front reduces tax obligations when these assets are disposed of. Sometimes, they are completely exempt from capital gains tax. If a holding company owns assets for several subsidiary companies, the capital losses incurred from other companies offset realized capital gains.
Owning Shares Directly or Via a Holding Company
Holding the shares of your company in a separate holding company offers the benefits of safeguarding profits. As mentioned, tax deferral and income splitting opportunities offer potential tax savings. For example, an active business may earn profits inside an operating company. These are subject to a relatively low corporate tax rate. These post corporate tax rate earnings could be distributed directly to shareholders as dividends. If individual shareholders receive the dividends, they are immediately subject to personal income taxes. They do receive a preferential rate because of the corporate income tax that has already been paid. However, if the dividends are received by the holding company and if the holding company owns over 10 percent of the voting and value shares of the operating company, then the dividends will move tax-free from the operating company to the holding company.
What Does This Mean For Your Dividends and Tax Savings?
This allows the whole dividend to get reinvested on a pre-personal tax basis. This could result in between 20 and 30 percent of additional capital that can be reinvested into the holding company. Personal tax liability is deferred. But this could be decades in the future when a person is looking to retire. Funds can be withdrawn from the holding company as dividends in a way that is controlled by an individual shareholder. They can be gradually withdrawn, allowing the individual shareholder to benefit from tax deferral and tax savings, especially if at the time of withdraw the individual or their family members are in a lower tax bracket. Dividends can be invested by a holding company into anything that an individual investor might invest in. This means there is a wide range of investment vehicles available, such as life insurance policies, real estate, private investments, etc. In most cases, the annual investment income earned via a holding company is subject to a tax rate that is like what an individual would pay. There are several upsides and no downsides to earning investment income via a holding company.
Should You Set up a Holding Company?
There are several advantages for business owners when setting up a holding company. However, the process can be complicated and requires strict adherence to federal guidelines. In this blog, we have barely scratched the surface of setting up a holding company and the holding company tax strategies that can be used.
At Fusion CPA, we work with holding companies throughout the United States. We can help you examine your current and future business plans when determining whether a holding company is right for you. Learn more about our tax services by clicking the button below to schedule a complimentary discovery call today.
This blog article is not intended to be the rendering of legal, accounting, tax advice or other professional services. Articles are based on current or proposed tax rules at the time they are written and older posts are not updated for tax rule changes. We expressly disclaim all liability in regard to actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive.