Is a Subsidiary in Your Future? Companies Can Benefit from Important Tax Advantages and Liability Protections
EXECUTIVE SUMMARY * CERTAIN DEVELOPMENTS IN A COMPANY'S LIFE CYCLE can trigger the need for a subsidiary, such as the launch of a new venture with different risk characteristics than the company's existing line of business or the opening of operations in a new state or foreign country. Other times, companies need to form subsidiaries to facilitate the potential sale of part of the company. * FROM AN ACCOUNTING PERSPECTIVE, creating a subsidiary makes sense because it allows companies to enjoy substantial tax benefits and creditor protections. The costs involved can be as little as a few thousand dollars for smaller companies, and when costs are higher, they are almost always nominal compared with potential rewards. * THE PRINCIPAL TAX BENEFIT associated with adopting a subsidiary structure is the ability, on federal income tax returns, to offset profits in one part of the business with losses in another. Forming a subsidiary also can provide tax benefits at the state level. * WHILE CREATING A SUBSIDIARY will clearly help to achieve corporate aims, companies and their advisers must structure the deal so it does not run afoul of federal tax, employment and benefit regulations. Companies must be especially mindful of the rules governing qualified plans, such as pensions or profit-sharing vehicles subject to federal laws. * CPAs WHO ADVISE on when and how to create a subsidiary should have strong grounding in tax regulations, particularly those relating to intercompany transfers of assets or liabilities. It happens every day: One company decides to buy another or it enters into a new line of business and comes face-to-face with the question of whether to structure the new venture as a separate legal entity--a subsidiary--or simply fold it into the company's existing operations. For CPAs whose employers or clients may be growing beyond a single-entity structure, this article explains when it makes sense to take the subsidiary route. Certain routine developments can trigger the need for a subsidiary. Often, says CPA and tax attorney Mike Farra at Miami-based CPA firm Morrison, Brown, Argiz & Co., it will be the launch of a new venture that has different risk characteristics than the company's existing line of business or the opening of operations in a new state or foreign country. Other times, companies need to form subsidiaries to facilitate the potential sale of part of the company. From an accounting perspective, creating a subsidiary generally makes sense under any of these conditions because it allows companies to enjoy substantial tax benefits and creditor protections. There are costs involved--hiring attorneys to draft and file the necessary legal documents, for example, and paying CPAs to handle marginally more complex tax returns. But those costs may be measured in as little as thousands of dollars for smaller companies, and even when costs are higher, they almost always are nominal compared with potential rewards from legal protections and tax benefits. TAX RELIEF The principal tax benefit associated with adopting a subsidiary structure is the ability of a company, on federal income tax returns, to offset profits in one part of the business with losses in another. Suppose, as an example, John Doe owns J.D. Frames Corp., which makes specialty truck frames. Doe decides to buy a struggling manufacturer of automobile wheels, Wild Wheels Inc., which he believes he can turn around. In the acquisition year, the frame company generates a profit of $10 million, while the wheel company posts a $5 million loss. If Doe operated those businesses as two completely separate corporations filing separate tax returns, the wheel company would owe no federal income tax but the frame company would owe tax on its $10 million profit. But what if Doe decided to form a holding company--called Doe Industries Inc. …