Key Takeaways:

  • A subsidiary is a separate legal entity owned or controlled by a parent company.
  • Creating a subsidiary involves choosing a business structure, filing state documents, and establishing governance.
  • Legal and tax compliance, including EIN registration and foreign ownership rules, are essential.
  • The subsidiary may offer liability protection, tax advantages, and operational independence.
  • Companies should evaluate state laws, foreign ownership rules, and long-term business goals before proceeding.

Understanding how to create a subsidiary under my corporation first requires understanding what a subsidiary is. A subsidiary is a business that is owned wholly or majority owned by another corporation. The subsidiary, most often, operates in a complementary service to the parent company. Saturn is an example of a subsidiary under General Motors Corporation.

To answer the question of how to create a subsidiary under my corporation, understanding the restrictions put forth by the IRS should be first priority. The parent company, or S corporation, must own 50.1 percent or more of the stock, membership interests, or other equity of the subsidiary. An S corporation is another term for a regular corporation that is formed when the articles of incorporation are filed with the secretary of state. S corporations pay taxes on the income as it is distributed, not on a corporate level. When dealing with existing corporations, or S-corporations, certain restrictions are in place by the IRS. Some of the restrictions include that:

  • there can be no more than 100 shareholders
  • the owners must be U.S. citizens or permanent residents
  • the S-corporation can own no more than 80 percent of the stock of another corporation
  • that S-corporations cannot wholly own a subsidiary, but a majority ownership is allowed

Steps Required to Create a Subsidiary Under an Existing Corporation

The creation of a subsidiary under an S Corporation requires that specific steps be followed to confirm they fall under the stipulations of the Internal Revenue Code.

  1. The board of directors must meet to authorize and vote to form a new subsidiary. If the board votes and it passes by a majority, a resolution should be drafted and signed by the chairman of the board to document the ruling. All actions within this meeting should be recorded in the meeting minutes and archived for future reference.
  2. The type of entity must be selected, such as an LLC or a corporation. These options allow for the existing company to maintain and hold all interest in the subsidiary while also allowing independent legal status to be established in relation to liability. In this case, the liability of each company is separate. The entity type decision has important tax implications and should be thought out before selected.
  3. Draft the documents required by state law that explains the company formation. Each state will have specific requirements for the type of business. For example, articles of incorporation for a corporation, or articles of organization for an LLC. State requirements vary but typically include the new company name, business address, and the name and address of the registered agent who can receive and accept mail on behalf of the company. The articles must include if the existing company is a sole shareholder or owner of the new company. A provision stating that amending the articles is prohibited should be listed.
  4. File all required documents and pay the specified fee with the state business registrar. The secretary of state's office in most states accepts new business filings. The secretary of state's websites are the most efficient way to obtain instructions and approved templates for both articles of incorporation and organization. When the filing has been accepted by the state, the company is deemed to exist.
  5. Add capital to the new entity and transfer any necessary assets so it can begin operations. The capital and assets are made in exchange for the company's ownership interest in the new subsidiary. All transactions should be recorded in the subsidiary's accounting software as a credit to the parent company.
  6. The subsidiary's bylaws must be established. Draft the bylaws which must include how the parent company will proceed in nominating, accepting, or changing members of the board of directors. The bylaws must also include the stipulation that any changes to the bylaws are prohibited unless permission has been granted by the parent company who is the sole owner.
  7. A board of directors must be appointed and installed. The board is tasked to manage the subsidiary as an independent entity from the parent company.

Once the board of directors is put into place and they begin to manage the subsidiary, the company is considered a fully functioning entity.

Common Challenges and Risks

Creating a subsidiary also comes with challenges. These include:

  • Regulatory complexity: Managing compliance across multiple jurisdictions.
  • Double taxation: In some scenarios, income may be taxed at both the subsidiary and parent level.
  • Cultural integration: Particularly with international subsidiaries, differences in culture or management style can affect operations.
  • Oversight burden: Even with a separate board, the parent company may need to provide ongoing support and governance.

These considerations underscore the importance of clear governance policies and a thorough setup process.

Establish Operational Independence

While the parent company may exert significant control, it's advisable to maintain the subsidiary’s independence in day-to-day operations. This includes setting up separate offices (if applicable), maintaining independent financial records, and issuing contracts under the subsidiary’s name.

Doing so can help preserve the subsidiary’s limited liability status and shield the parent company from potential legal claims tied to the subsidiary's operations.

Understand the Tax Implications and Benefits

Subsidiaries can offer potential tax benefits. For instance, expenses incurred by the subsidiary can reduce taxable income. In some cases, the parent company can deduct losses from the subsidiary if they file a consolidated tax return (only available for C corporations).

However, subsidiaries are considered separate legal entities, so they must file their own federal and state tax returns. Work with a qualified tax professional to ensure you’re meeting all obligations and optimizing your tax position.

Open a U.S. Bank Account and Set Up Financial Infrastructure

To operate efficiently, the subsidiary must open a U.S. bank account. Most banks require the EIN, formation documents, and verification of the company’s officers or owners. Consider engaging a U.S.-based director or representative to simplify the account opening process.

Establishing accounting software and a clear chart of accounts from the start will help the subsidiary maintain transparent records and facilitate audits or tax filings.

Comply with Foreign Ownership Laws (if applicable)

If your parent corporation is based outside the United States, be aware of additional compliance issues. Foreign companies can generally own U.S. subsidiaries, but certain sectors—such as defense, telecommunications, and aviation—may impose ownership limits or require government approval.

Moreover, foreign-owned subsidiaries may need to register with the Bureau of Economic Analysis (BEA) and comply with federal regulations concerning foreign investments.

Understand State-Specific Requirements and Compliance

Each state has unique requirements for registering and maintaining a business. When choosing a state for incorporation, consider factors such as business-friendly laws, tax rates, and ongoing compliance obligations like annual reports, franchise taxes, or publication requirements.

Some states, like Delaware and Nevada, are popular for their flexible corporate laws and favorable court systems, especially for companies expecting future investments or public offerings.

Register with the IRS and Obtain an EIN

After state registration, the subsidiary must obtain an Employer Identification Number (EIN) from the IRS. This number is used for tax reporting, opening business bank accounts, hiring employees, and fulfilling federal filing obligations. The EIN can be obtained online through the IRS website.

Additionally, if the parent company is foreign or has foreign shareholders, the subsidiary may need to file IRS Form 5472 to disclose transactions with foreign-related parties. Failure to comply can lead to steep penalties.

Consider the Type of Subsidiary Structure

When learning how to create a subsidiary company, it’s critical to determine whether it will be a wholly owned or partially owned subsidiary. A wholly owned subsidiary is 100% controlled by the parent company, offering maximum oversight but with increased compliance obligations. In contrast, a partially owned subsidiary may include other investors or stakeholders, which could introduce outside influence.

You’ll also need to decide between forming a corporation or a limited liability company (LLC) as the subsidiary’s legal structure. While both offer limited liability protection, they differ in governance requirements, tax treatment, and ownership flexibility. Consulting a legal or tax advisor can help determine the optimal structure based on your business goals and tax strategy.

Frequently Asked Questions

1. Can a parent company be held liable for its subsidiary’s actions? Generally, no. A subsidiary is a separate legal entity. However, if corporate formalities are not observed or there’s evidence of fraud, courts may “pierce the corporate veil.”

2. Can an LLC be a subsidiary of a corporation? Yes. A corporation can form an LLC as a subsidiary, and the LLC’s operating agreement can designate the corporation as the sole or majority member.

3. Is it necessary to have a physical office for the subsidiary? Not always. Some states allow registered agent services for compliance. However, having a physical presence may be required to open bank accounts or obtain certain licenses.

4. What is the difference between a branch and a subsidiary? A branch is not a separate legal entity and is directly tied to the parent company. A subsidiary is legally distinct and provides liability protection.

5. How long does it take to create a subsidiary company? The timeline varies by state and structure but generally takes a few days to a few weeks, depending on how quickly documents are prepared and processed.

If you need help with how to create a subsidiary under my corporation, you can or post your job on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.