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Exploring the Potential of Holding Companies: Should You Restructure Your S Corp or C Corp?
Business owners often consider restructuring their corporations to optimize tax advantages, enhance asset protection, or streamline operations. One potential restructuring strategy is to create a holding company, which can offer several benefits. In this article, we will explore the concept of a holding company and discuss whether restructuring your S Corp or C Corp to create one is a wise decision.
Understanding Holding Companies
A holding company, also known as a parent or investment company, is a type of business entity that doesn’t engage in operational activities itself but owns and controls other companies or assets. Its primary purpose is to manage and hold ownership interests in subsidiary companies, which can be S Corps, C Corps, LLCs, or other entities.
Benefits of a Holding Company Structure
- Asset Protection: One of the significant advantages of a holding company structure is the separation of assets. By creating a separate entity to hold ownership interests, you can shield valuable assets from potential risks and liabilities associated with operational activities. This structure can provide an added layer of protection for your personal and business assets.
- Tax Planning: Holding companies can offer potential tax benefits, depending on your specific circumstances and jurisdiction. They can facilitate tax planning strategies such as income splitting, intercompany transactions, and tax deferral. Additionally, holding companies may allow for efficient estate planning and succession strategies, enabling the transfer of wealth between generations with reduced tax implications.
- Simplified Business Operations: If you own multiple businesses or subsidiaries, a holding company structure can streamline management and operations. By consolidating control and decision-making at the holding company level, you can centralize financial management, reduce administrative complexities, and allocate resources more effectively across the subsidiaries.
Restructuring S Corp or C Corp to Create a Holding Company
When considering restructuring your existing S Corp or C Corp to create a holding company, several factors must be carefully evaluated. Here are a few key considerations:
- Legal and Tax Implications: Consult with legal and tax professionals to understand the specific legal and tax consequences of restructuring. Factors such as entity formation costs, potential tax implications, and compliance requirements can vary based on your jurisdiction and the nature of your business.
- Shareholder Approval: Restructuring a corporation typically requires shareholder approval. Communicate with your shareholders, outlining the proposed benefits, risks, and long-term goals of the restructuring plan. Their support and understanding are crucial to ensure a smooth transition.
- Administrative and Operational Changes: Establishing a holding company may involve administrative and operational changes, such as revising contracts, transferring assets, and reorganizing management structures. Proper planning and execution are necessary to minimize disruption to ongoing operations.
- Future Growth and Expansion: Assess whether a holding company structure aligns with your long-term business goals. Consider factors like scalability, financing options, and potential regulatory implications. Evaluate if the holding company structure supports your strategic vision and growth plans effectively.
Restructuring your S Corp or C Corp to create a holding company can provide several advantages, including asset protection, tax planning opportunities, and streamlined operations. However, such a decision should be made after careful consideration of legal, tax, and operational implications. Consulting with experienced professionals is crucial to ensure a smooth and successful transition.
Remember, every business is unique, and what works for one may not work for another. Carefully assess your specific circumstances, seek expert advice, and evaluate the potential benefits and risks before making any restructuring decisions.
Should You Restructure Your S Corp or C Corp to Create a Holding Company?
“In Minnesota, my understanding is that we can’t have serial or series LLCs. If my wife and I have multiple businesses that are LLCs, does it make sense to restructure them to S corporations or C corporations so we can create a holding corporation?”
Well, the standard caveat here is that it takes time. I would recommend working with an attorney who can take the time to understand your circumstances and risks and goals to design a plan that works for you. But let’s just talk about this a little bit generically. So you can’t have a series LLC in Minnesota, sometimes called a serial LLC. Some states allow for that. You might wonder, well, what is that? That is where you set up one entity, and you can create new divisions, if you will, which are essentially new LLCs without having the cost associated with filing all of those. You still have to run them as separate entities and keep them separate from each other. Otherwise, the alter ego doctrine comes in or the piercing the corporate veil doctrine comes in. So in Minnesota, you still need to have separate entities to separate liability. Let’s assume you have a number of separate entities, whether they are corporations or LLCs doesn’t matter. They all isolate liability within each entity as long as you preserve the separation between each entity. So that means separate bank accounts, not commingling funds, not commingling assets and employees. If you have an employee who works for two of them, they properly record their time for each one and then get paid the appropriate number of hours from each entity’s bank account.
Safeguarding Assets with a Holding Company Structure
So assuming you preserve the separation between these entities, does it make sense to restructure them so you can create a holding company? The purpose of a holding company is to protect expensive or valuable assets. So what you would typically do is create a new LLC as your holding company. And then you would sell the assets from your other businesses to that holding company. Now you might say, “Well, how do I get the money in that holding company to buy these assets?” well, let’s say that one of your LLCs has $50,000 in profit, which they pay to you. You can make a capital contribution or loan to your holding company. So now that holding company has $50,000 and then that holding company uses that $50,000 to buy the assets of your operating LLC. So maybe it buys gym equipment or a tractor or whatever that might be. We buy those assets into the holding company. And of course, all this is coming from you or your LLCs. But as long as you follow the formalities when moving the money, limited liability is preserved.
Contracts and Successor Liability in Restructuring
So let’s imagine now you get all the assets into the LLC holding company. Then you have contracts between the holding company and the companies that need to use the assets that are in there. So you have a lease, for example, a tractor lease or an equipment lease. Now, if there is ever a lawsuit, the lawsuit is going to be against the operating business, the gym, the company providing tractor services, or whatever. The company that has employees and contracts and customers and clients, is your operating company. The lawsuit goes against that. They don’t have any basis to sue the holding company because the holding company is just a lease for the equipment. So should that operating company go down in flames from a lawsuit? The assets are still protected in the holding company. And what happens typically then is the owner of both starts a brand new LLC, a new operating company sets up a new lease with the holding company and starts operating again, and might even hire all the employees from the old company that went down in flames and might even reach out to all the customers and says, “Hey, we have a new business. The old business needed to close. The new business is open. Now we would like to continue to service you (or “continue” is the wrong word), but we would like to service you through the new business and provide the same services you receive from the old company.”
Benefits and Considerations of S Corporations and C Corporations
One risk here is the doctrine of successor liability. If you have assets moved from an old company that goes down in flames from a lawsuit, and those are just gifted to the new company, or assets are transferred without any payment for that, and contracts setting that up, successor liability can attach. Because the court basically says, “Hey, you just moved the assets from one entity to another. And now you are trying to operate under another entity. That new entity is going to be liable for the old entities, lawsuits or claims, or any other responsibilities that the old entity had. So that is why it is important to have contracts between your entities and a payment that occurs and that payment can be funded as we discussed through your own money or a profit distribution from one of your existing LLCs. And I would typically use an LLC for a holding company. The benefit of an S corporation over an LLC is when you are providing work for the S corporation, and maybe it is a very small amount of work, but an S corporation can limit the payroll tax that it pays, or the self-employment tax. It goes by different names, but it is essentially 15% of whatever’s paid you. In an LLC, you are required to pay a self-employment tax of 15%. I have another video on that whole issue of LLC versus S corp, so I won’t go into it deep here.
Weighing the Costs and Benefits of Complex Entity Structures
The question also relates to C corporation. Let’s talk about what that is for a second. A C corporation pays tax twice and it pays tax at the corporate level and then at the personal level. And when I say tax twice, I am talking about income tax. So corporations pay tax on their profits. And then when the profits are passed on to an owner, the owner pays income tax again. So you usually see corporations that don’t make sense. That said, there are some business attorneys who set up carefully designed entity structures, and they will use a corporation, because corporations have some tax benefits, and then typically, what they will do is prevent having any profits in the C corporation.
Simplicity as a Preferred Approach
What would otherwise be profits of the C corporation gets paid out to an LLC or S corporation. So because there are no profits at the C corporation level, there actually are no income taxes paid. And so you are getting the benefits of a C corporation without getting hit with that second layer of tax. That is a more complex structure. It may make sense for larger companies or companies with significant assets or business owners with significant assets. And I am talking millions of dollars. Typically, the cost of setting this up and the cost of maintaining a complex structure is significant. It involves CPAs filing tax returns for multiple entities. It involves attorneys drafting contracts between these. And it also makes it difficult for you to make decisions about the business because every time you go to do something, it is not simple. You have to run it by a CPA and attorney and say, “Hey, which entity will do this and how will that affect my taxes? And do we need to change any rates on things?” So it might be worth spending thousands of dollars a year, maintaining a complex structure if you are saving tens of thousands a year, but most small businesses are not in that scenario, and for them, simplicity is better. By the way, too, a holding company, isn’t a great solution for everyone. I often recommend utilizing insurance to minimize your risk in LLCs, rather than creating a more complex structure with a holding company.
Thanks for joining us today. If you would like to find out more, check out our YouTube channel. We have a lot of similar topics there. And if you have questions that weren’t answered today, I would love for you to submit them. You can submit them by email or by adding a question in the comment section below. Have a great day.