A holding company owns shares of another company- typically an operating company. While each situation should be assessed for suitability by a tax professional, business owners should be aware of some key benefits of utilizing holding companies.
The opportunity for tax deferral is significant. By having dividends flow to a holding company, rather than to an individual shareholder, the dividends will generate no immediate tax consequences—assuming certain criteria are met.
This allows funds accumulated in a holding company to be reinvested, rather than incurring immediate taxes in the hands of the shareholder. While taxes will be eventually incurred when funds are distributed to the individual shareholder, the tax savings prior to distribution allows for wealth to accumulate in the holding company, which can be invested in securities, real estate, etc.
Splitting income among shareholders in a more tax-efficient manner is another key benefit. For instance, if various family members own shares of a single operating company, when a dividend is declared the individuals must report the dividends received as income on their personal income tax returns. However, depending on personal tax situations, one individual may want to defer receipt of the funds while another may want to receive the funds immediately. If each shareholder has a holding company which owns the shares, the holding companies can receive the dividends tax-free and subsequently each individual can decide whether to receive the funds immediately or retain the funds in a holding company for reinvestment.
Creditor protection is high on the agenda of most business owners, which stems from a multitude of risks facing many operating companies. A holding company is more likely to be sheltered from claims by creditors and liabilities arising from legal disputes since it is separate from operations. If necessary, the holding company can lend funds back to the operating company as a secured creditor.
Holding companies may assist with succession planning by allowing the transfer of wealth to the next generation. An estate freeze allows shares in an operating company to be transferred to younger family members through a holding company. This transfers any future growth to the younger generation and fixes the tax liability on the transferor’s death.
Finally, the exit-strategy of shareholders is made simpler by separating investment assets from the operating company. An outside party will likely be interested in purchasing the assets of the operating company or holding company, but often not both. Selling shares of each entity separately is more desirable than moving assets out of the operating company prior to the sale, which may result in some or all of the transfer being taxed.
While a holding company will add some additional complexity to a corporate structure, the above benefits will often save business owners significant taxes and headaches. One of our tax professionals will be pleased to assess your situation to determine if a holding company structure is right for your business and financial planning objectives.