How does a holding company work?
SHORT ANSWER
Your operating company runs the business. Your holding company owns shares of it. Profits can move from the operating company to the holding company as dividends, often without immediate tax, and be invested there.
A simple way to picture it: the operating company is the storefront, where the risk is. The holding company is the vault, where you keep what you've earned.
Why do business owners use a holding company?
- Protection: money moved out of the operating company is further from its business risks and creditors.
- Tax deferral: profits taxed at the lower corporate rate can be invested in the holding company instead of being paid out and taxed at personal rates right away.
- Flexibility: it can help with family ownership, estate planning and future investments.
Does every business need one?
SHORT ANSWER
No. Holding companies cost money to set up and maintain, with separate accounts, bookkeeping and tax returns. For businesses with modest profits, the costs can outweigh the benefits.
A holding company only works if it's actually used. One that exists on paper, with no bank account or transactions, gives you none of the benefits.
How does a holding company affect selling your business?
SHORT ANSWER
It matters a lot. The Lifetime Capital Gains Exemption is claimed by individuals selling their own shares. If your holding company owns the operating company, the way the sale is structured, and what the holding company itself owns, can decide whether you can use the exemption. Plan this with your CPA at least 24 months before a sale.