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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