The Advantages of a Subsidiary Corporation

By Ed Haman

The Advantages of a Subsidiary Corporation

By Ed Haman

One of the key benefits of forming a corporation is the ability to limit the personal liability of the business' owners. A key reason to form a subsidiary corporation is to limit the liability of the first corporation. However, creating a subsidiary can also involve other advantages.

What is a Subsidiary Corporation?

In simple terms, a subsidiary corporation is a corporation that is owned by another corporation. The entity that owns the subsidiary is called the parent corporation. If the parent corporation does not conduct any business activities of its own, and only exists to own the subsidiary, it is also called a holding company.

A parent corporation does not need to own all of stock of the subsidiary but it must own enough of the stock to retain control of the subsidiary. If the parent company owns all of the stock, the subsidiary is considered a wholly owned subsidiary.

How to Use and Create of Subsidiaries

A common example of how subsidiaries are used involves real estate. For instance, a business with numerous rental properties forms a parent corporation. It then creates separate subsidiary corporations to hold title to each individual property, with the parent company as shareholder of each subsidiary. This way, if a lawsuit arises in relation to one property, the parent corporation and the other properties are protected.

A subsidiary corporation can be created in one of two ways:

  • The parent company can form a new corporation as a subsidiary.
  • The parent company can acquire a controlling interest in an existing corporation, thereby making the acquired company a subsidiary.

What are the Advantages of Subsidiaries?

In addition to limiting the liability of the parent corporation, subsidiaries may also offer the following advantages:

  • The subsidiary can establish its own brand recognition, and possibly increase the overall share of a market. Take, for example, General Motors subsidiaries Cadillac, Buick and Chevrolet.
  • The subsidiary can establish its own management style, methods of operation and corporate culture to fit the particular nature and location of its business and operations.
  • There may be tax advantages, especially if a subsidiary is organized in a different state or country from the parent company. For example, some states may tax on a company's entire profits, while, in others, only the subsidiary's profits are taxed.
  • The subsidiary may be able to attract new investors who might not be interested in the parent company.
  • Having subsidiaries may make it easier, and cheaper, to merge or sell company subdivisions in the future.
  • A parent company that is set up as a nonprofit corporation can set up a subsidiary corporation to engage in profit-making activities, while maintaining the parent's nonprofit status.

What are the Disadvantages of Subsidiaries?

Subsidiaries can also come with some disadvantages, such as:

  • The parent corporation and each subsidiary must have its own articles of incorporation and bylaws, file its own registration documents with the appropriate state agencies and pay any associated fees, issue its own shares of stock, keep a separate set of books, hold its own annual shareholder meetings, keep its own minutes of shareholder and director meetings, and file its own tax documents with both the Internal Revenue Service (IRS) and state tax agencies.
  • If the parent and subsidiary are engaged in activity that requires some type of licensing, separate licenses will be required for each entity.
  • If the operations of the parent and subsidiary corporations become blurred, or transactions between the two companies are not conducted at arm's length, protection from liability can be lost. In the case of a nonprofit with a for-profit subsidiary, the nonprofit's tax-exempt status could be lost.
  • If your parent company has elected S corporation tax treatment, you will need to understand the IRS rules regarding a qualified S corporation subsidiary (or QSub).

Variations and Options

One variation of the parent and subsidiary structure is to organize either or both as a limited liability company (LLC). Whether any company should be organized as a corporation or LLC will consider several factors, such as taxation, cost of formation, legal requirements for operations and reporting, and the number and nature of the shareholders or members.

If you prefer to operate your business as an LLC and you organize your business in Alabama, Delaware, the District of Columbia, Illinois, Indiana, Iowa, Kansas, Minnesota, Missouri, Montana, Nevada, North Dakota, Oklahoma, Tennessee, Texas, Utah or Wisconsin, you may want to consider forming what is called a Series LLC. This provides limited liability like subsidiary corporations, but without the expense of setting up and maintaining separate entities.

In the right situation, setting up a subsidiary corporation can offer significant liability protection as well as various other benefits.

This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.