Should I Separate My Company into Multiple Entities?
When business owners separate their businesses or activities into different companies, this can create a liability shield. If done correctly, this means that if one of your companies has significant liability, the creditor can only go after the assets of that single company. As a result, your other companies will not be responsible for that debt.
The main questions to consider when it comes to separating your business into multiple entities are when to separate, how to do it, what the tax consequences could be, and what potential downsides are.
When to Separate
It’s cleanest if you start your business activities as separate entities rather than trying to split them down the road. A later action may result in tax consequences. Additionally, for any liabilities accrued prior to the separation, the creditor could go after either company.
However, there are many cases where one company happens to grow over time, and a business owner decides to separate it into multiple companies later on. If this is the case, it can still work.
How Many Companies Should You Have?
Let’s think of a simple example of a company that owns residential rental houses. Houses A and B are in the Denver Metro area. Houses C, D, and E are in Fort Collins. House F is a mountain property that the owner uses mostly as a vacation property.
In this scenario, it might make sense to separate into three companies—one for A and B, one for C, D, and E, and one for F. It also could be worthwhile to have a separate company for each house. The number of companies you should have is dependent on the circumstances.
Keeping Things Separate
It’s important to understand that if you have multiple entities, you have to keep them separate in many ways. If you don’t treat them like they are separate companies, then a creditor may not have to treat them as separate either. Consequently, the liability shield may not work.
Each company should have its own bank account. Revenue from that company’s operations should be deposited in that account, and its expenses should be paid from that account. If you need to use money from another company, you should document that as a loan or otherwise carefully show that they are truly separate companies.
There may be transactions between two affiliated companies, such as one company leasing real estate owned by another company and paying rent, or one company using employees of another company and paying for that use. That should be documented, perhaps with a written agreement that explains the arrangement.
Structuring Strategically
Keep in mind that the structure of your companies can affect how good the liability shield is. If one of your companies owns another one of your companies, they are referred to as a parent and a subsidiary.
In this case, the liabilities of the subsidiary usually do not have to be paid by the parent company. But if the parent company has a creditor, then the creditor could have access to all of the parent company’s assets, including the ownership of the subsidiary.
If the companies are “brother-sister” companies, meaning that they are owned by the same person or holding company, the liability shield is stronger.
One structure to consider is to have a holding company that you own and that has no operations. Its sole purpose is to own the equity of both of the operating businesses. In that case, the operating businesses are “brother–sister” companies.
Tax Structure
And finally, the structure you use needs to be carefully analyzed to determine the tax consequences.
You may find that you want different types of tax structures for different activities. Tax treatment as a “C” corporation rather than as an “S” corporation may be beneficial in some cases. Tax treatment as a “disregarded entity” or a partnership may work best in others.
It is easy to fall into a tax trap. Separating business activities into different companies can result in taxes becoming due right away. Also, having multiple companies may create additional tax returns and additional costs.
Reach Out Today
Our team at MKP Law can help you understand more about the structure of your businesses and activities. If you have questions or would like more information, reach out to us today, and we can talk about your goals and what might work best for you.