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Holding Company & Operating Company (ies)

Establishing a holding company and one or more operating companies is popular for professional groups such as  physicians, lawyers, and other professional services providers and when a husband and wife have one or more businesses in different industries.

Holding company and operating company arrangements are attractive as they provide flexibility for the future as you can easily expand ownership in your operating company without affecting your holding company, add operating companies as you may expand the number of businesses in your enterprise, and carve off companies when it is time to sell. The holding company is a vehicle to build wealth separately from your business(es). 

A challenge is to know which businesses should be LLCs, S-corporations, etc. 

Parent-Child Business Structure A

You (or you and your spouse) may have or planning to have multiple businesses in your household that are in completely different industries. For example, you may be in or pursuing Real Estate, your spouse Consulting, and a business in digital marketing.  


You could set up a holding company LLC such as "xxx Enterprises" taxed as a S-corporation and set up an LLC for the real estate company, an LLC for the Consulting business, and an LLC for the Digital Marketing company. The holding company would own the LLCs (taxed as disregarded entities), and net income of generates by the LLCs would flow to the holding company taxed as an S-corporation. To make this arrangement work, each business must have a profit motive (and avoid hobby loss limitations).

The subsidiary LLC’s can have basic operating agreements since its sole member is the holding company. The holding LLC might need a more complex operating agreement to address legal issues and/ or estate planning goals.

Another benefit is that one of these businesses can be easily carved off and sold as convenient without disrupting you household Holding Company enterprise. 

Each entity should have its own checking account and set of books. Common expenses such as an umbrella policy or tax preparation fees would be paid at the S corporation level, while subsidiary-specific expenses such as website hosting would be paid at the LLC level.


Parent-Child Business Structure B

In this example, if the facts remain the same, however your spouse plans to have a partner in the consulting company, purchase equipment, add staff, etc. this is an option to consider adjust the arrangement. This multi-entity arrangement allows for that. In this example, your holding company would receive a K-1 for own 50% +/- (whatever is agreed upon) of the consulting LLC net income and separately-stated items, and the partner the other half. 

Parent-Child Business Structure C

Here is another option when one spouse has a company with a non-spouse member, as S corporations (and LLCs taxed as S-corporations) require distributions be made in the same percentage as ownership. 

If your spouse's LLC was not taxed as an S corporation, the Operating Agreement could create whatever schedule of distributions it chooses. They could be 50-50 partners (capital accounts are 50/50), but the have the allocation of profits and losses, and distributions, tied to, for example, the volume of revenue each brings in each year. If this is the goal, you'll want to stay clear of electing for the consulting LLC to be taxed as an S-corporation - which may have been your initial plan, to save on self-employment taxes. Talk to us before you make decisions! 

If the 50% / 50% allocation of profits and losses is fine, having the consulting company LLC taxed as an S-corporation would work (be mindful if/when one shareholder begins to outwork the other, friction is bound to arise, and chances are you will later regret it).

This multi-entity arrangement allows for each owner to have discretion within his  or her S Corp for fringe benefits -an essential consideration. For example, if each owner is getting an automobile and one want's a Honda and other a Mercedes, the benefit to each owner will be dramatically different. Fringe benefits such as home office deduction expense, paying children and more can get messy if a company doesn't plan ahead to equal the playing field. With each owner having his/her own S corporation is the answer. 

The Consulting LLC (MMLLC) taxed as an S-corporation would not pay salaries to its shareholders since the income is so low, and the plan is there will not be any cash available. Distributions will be close to $0 as all the cash is leaving the company in the form of payments to each owner's holding company, or to them personally. 


Fee For Service Arrangement in California

The problem with the previous MMLLC entity structure issuing invoices and/or or makes fee for service payments is that this doesn't work in California if minimizing tax expense, namely the LLC fee, is important (it always is). California’s LLCs - regardless of how they elect to be taxed - are required to pay a fee based on the volume of gross receipts. If the business makes a $1,000,000 in revenue, regardless of the amount of expenses, the LLC will still pay the LLC franchise tax fee on the $1,000,000. The fee increases as revenues increase, it is not a straight calculation based on a percentage, and it's generally not attractive to begin the business with a deterrent to maximizing revenue. 

The solution is to have the  businesses that were previously LLCs set up as S corporations. After paying the other S corporations a fee for Payments for Services Rendered or Outside Contractor or something similar, the MMLLC S Corp will have very little taxable income, such as $1,000. A franchise tax will be computed by California at 1.5% x $1,000 or $800, whichever is higher, versus significantly more. 


Additional Multiple Entity Considerations

In addition to have detailed operating agreements, here is a list of items that will require special attention:

Health Insurance

You will need to consult with your your health insurance provider to discuss how the health insurance needs to be set up, and administered. Will the primary entity pay for it, and each S Corp reimburses the primary entity? Can the policies be split up and paid by each S Corp separately, or does that mess up the group policy rates? 

Professional Liability

Professional liability policies need to be addresses similar to health insurance polices. Ideally the policy will be maintained at the primary entity level. For example, an errors and omissions policy could be held by the company, with each partner covered by the single policy, and addressed in the Bylaws and Shareholder Agreements. 

Licensing and Compliance

If your trade or profession is governed by a regulatory body, you’ll need to ensure the multi-entity arrangement is in compliance. Typically governing regulatory bodies want to ensure two things; first, the people in control are the ones licensed, and second, the licensed people are the ones earning revenue from the practice - i.e. business with a group of, for example, physicians, having individual licenses.

401k Plans

401k plans are ideally implemented at the primary entity level, with each S Corporation adopting the plan as an adopting employer. Your 401k plan administrators can help set this up. 


Layered Entity Structures

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