Holding company tax implications are important for you to be familiar with if you own shares of a corporation.3 min read updated on February 01, 2023
Updated July 9, 2020:
Holding company tax implications are important for you to be familiar with if you own shares of a corporation. If you receive any dividend payments from the company, there will be tax consequences. On the other hand, if you have a holding company of your own that owns your shares in the corporation, dividends paid to your company will for the most part be tax-free.
Subsection 112 of our country's tax law allows your holding company to receive a deduction for dividends received from your corporation. To avoid the so-called "Part Four" tax, your corporation and company have to be "connected," according to tax law. For people in the top tax bracket, the tax that is deferred is approximately 30 percent of their taxable income in most provinces.
What Is a Holding Company?
If you are planning on investing in companies through stocks, securities, or bonds, you will encounter the term "holding company." Many of the most successful companies in the world are holding companies.
A holding company is one that doesn't have any activity, operations, or the business itself. Rather, this type of company owns shares in another company, and that is its only purpose. The assets can consist of shares of stocks in:
- Limited liability companies
- Private equity funds
- Brand names
- Patents
- Copyrights
- Hedge funds
- Publicly traded stocks
- Anything that has value
It's helpful to look at the structure of a very well-known holding company, Johnson & Johnson. The company owns 265 individual businesses in the same manner that you would own shares of different companies with a brokerage account. The businesses are mainly in the pharmaceutical, consumer healthcare, and medical device sectors, but each stands on its own throughout the world. Each company has its own bank account, employees, manufacturing, and offices.
- At the top, Johnson & Johnson has a board of directors elected by stockholders.
- The board hires a CEO.
- The CEO hires subordinates.
- The subordinates determine the CEOs and executives of the companies Johnson & Johnson owns.
What Are the IRS Tax Implications of a Holding Company?
A thriving business might want to buy or create a new business for many reasons. You have to consider the business revenue, where the business owner lives, and his or her long-term goals for the business. A company can set up a subsidiary in order to enter into a risky business, and if the subsidiary fails, the parent company is not liable for the debt.
Legally, subsidiary and parent companies are separate. The subsidiary can make its own decisions with its own management without approval from the parent company. In most cases, the parent company stays in control by being the only shareholder or by creating subsidiary bylaws. Since the two companies are separate, each pays its own taxes on its own income.
The IRS has regulations in place to deter parent and subsidiary companies from moving taxable income around among each other. Starting in 2013, an international subsidiary cannot use American intellectual property without paying the parent company. A parent company is not liable for subsidiary taxes only if it's obvious that the two are operating independently. If the IRS sees that the two companies are actually one, it will ask for back taxes.
Strategies in Deferring Taxes
- Many shareholders. Creating a holding company for each shareholder in your corporation can give flexibility to each shareholder. Each holding company controls the dividend payments to each person.
- Splitting income. The holding company can be owned by more than one person. This allows the dividend payments and taxes on them to be divided.
- Create a trust. The shares of the company can be helpful in a family trust. You, your spouse, your children, and your holding company will benefit from this arrangement. Dividends can be distributed to your holding company as a beneficiary, and they are usually tax-free.
- Creditor protection. Profits from your company can be sent to the holding company in the form of dividends, and they can be sent back to the business if cash is needed. Any profits will not go to creditors but will stay within the business.
- Retirement funds. The assets within your holding company represent a type of pension that you can use once you are ready to retire.
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FAQs
Here are some general IRS tax implications for holding companies: Corporate income tax: Holding companies are typically subject to corporate income tax on their income, which may include dividends, interest, rental income, and capital gains from the sale of assets.
What is the downside of holding companies? ›
Disadvantages of holding companies
A holding company's majority control of a subsidiary allows it to appoint its own directors, management team and officers who can promote the holding company's interests. This comes at the expense of minority shareholders, who may get shut out from the decision-making process.
Is a holding company more tax efficient? ›
Tax efficiency – A holding structure limits tax liability, for example: A holding company can offset the losses and profits of its subsidiaries to reduce the group's overall tax liability.
What is the tax test for a personal holding company? ›
Personal Holding Company Tests
These criteria include the stock ownership test and the passive income test: 1. Ownership test: The ownership test is met if, during the last half of the tax year, five or fewer people own more than 50% of the value of the corporation's stock.
What is a holding company in short notes? ›
To sum it up, a holding company is a parent company that owns and controls other companies and in many cases does not produce any goods or services or conduct business operations of its own. Holding companies and operating companies are used by businesses of all sizes and in all industries.
How do holding companies avoid taxes? ›
The main tax advantage of a holding company is that it does not have to file different tax returns for each subsidiary company. Generally, subsidiaries can pay dividends to the holding company without creating a tax liability.
Are holding companies taxed differently? ›
Holding Company Tax Implications. Even though the parent company typically remains in control of its subsidiaries, the companies are considered legally separate. Because the companies are recognized as separate, each company pays its own taxes as it corresponds to their specific income.
Should I put my business in a holding company? ›
Most small business owners will find holding companies to be more trouble than they're worth. Unless you have multiple profitable companies with many assets you want to protect, you'll likely be better off with a simpler structure, such as forming multiple LLCs.
Why put property in a holding company? ›
A holding company prevents double taxation on investment properties. The business structure allows investors to more easily manage their properties. As a whole, LLCs pay less fees when compared to corporations. Holding companies provide investors with more flexibility to distribute their profits.
Should I create a holding company for my LLC? ›
If your business engages in legally or financially risky activities, you might consider using a holding company to keep valuable assets separate from potential liabilities. Setting up a holding company can be costly. In addition, a holding company needs to be well managed in order to maintain its legal protections.
Holding Company Taxation
As such, each entity files its own tax return and pays its own taxes on its own income. The IRS has rules in place to deter parent and subsidiary companies from moving taxable income around among each other.
How do I pay myself with a holding company? ›
As the owner of a corporation, you can pay yourself a salary or receive dividends. To pay yourself a salary, you need to set up an employment agreement with the corporation and become an employee. You'll receive regular paychecks like any other employee, and taxes will be withheld from your salary.
Should a holding company have an EIN? ›
All corporations must have a federal tax ID number to do business, and there are only rare situations (a holding company that does not pay tax of any kind) where an LLC wouldn't need an EIN. Your tax ID number will be required to fill out payroll reports, pay taxes, open a business checking account, etc.
What are the advantages and disadvantages of a holding company? ›
Holding companies can offer a number of advantages, including the ability to operate your business and ensure that your family receives the income from your business. However, holding companies also have a number of disadvantages, including limited liability protection and high costs.
What is another name for a holding company? ›
Holding companies, which are sometimes called "parent companies," control the assets of other companies, known as subsidiaries.
How does a holding company make money? ›
A holding company generates revenue through various channels, including dividends from its subsidiaries, income from its assets, and royalties from patents or copyrights it holds. This diverse income stream contributes to its financial stability and growth.
Is it a good idea to have a holding company? ›
The Bottom Line
Holding companies can help protect their owners from losses, or they can also be used to reduce tax burdens.
Are holding companies a good idea? ›
Yes, a holding company can offer substantial asset protection. Because the holding company itself typically does not engage in business operations, its assets are shielded from the operational risks and liabilities of its subsidiaries.
Is it worth having a holding company? ›
Lessen liability
Entrepreneurs typically form a holding company to limit liability risks when owning multiple businesses. Each subsidiary is protected from the legal claims against and debts of the other subsidiaries.
