Three Instances of When You Need a New Subsidiary Entity for Your Business

Photo of an empty, minimalist boardroom overlooking an empty field.Are you growing your business? Adding new products or services? New locations? Adding partners or owners? If so, these are all instances when you should consider setting up a subsidiary or other new entity for your existing company. While you can run multiple streams of business through one entity, there are tax, asset protection, and partnership reasons why you may want to open up a new subsidiary entity for your new activity.

Let’s run through a few common situations when it makes sense to open up a subsidiary entity. And by subsidiary, I mean “a new entity which is owned wholly or partly by your primary business entity or by a common holding company.” Your new subsidiary could result in a parent and child relationship where your primary entity (parent) owns the new subsidiary entity (child), or it could be a brother and sister type structure where the primary business is a separate entity (brother) to the new entity (sister) and the two are only connected by you or your holding company that owns each separately and distinctly. (See the diagrams below to view the differences.)

I. Adding a New Product or Service

You may want a new entity to separate and differentiate services or products for liability purposes. For example, let’s say you are a real estate broker providing services of buying and selling properties and you decide to start providing property management services. Because the property management service entails more liability risk, a new entity owned wholly by your existing business could be utilized. The benefit of the new subsidiary is that if anything occurs in the new property management business, then that liability is contained in the new subsidiary and does not go down and affect your existing purchase and sale business. On the other hand, if you ran the property management services directly from the existing company without a new subsidiary and a liability arose, then your purchase and sale business that is running through the same entity would be effected and subject to the liability.

For tax purposes, in this instance, the income from the new subsidiary entity (child) will flow down to the parent entity without a federal tax return, and as a result, there is no benefit or disadvantage from a tax planning standpoint.

 

Diagram displaying the Parent-Child Subsidiary structure

 

II. Opening a New Location

What if you’re establishing a new retail or office location for your business? Let’s say you are a restaurant opening up your second location. For asset protection purposes, you should consider setting up a second entity for the new location. This can limit your risk on the lease (don’t sign a personal guarantee) for the new location or for any liability that may occur at the new location. In this instance, if one location fails or has liability, it won’t affect the other location as they are held in separate entities. The saying goes, “don’t put all your eggs in one basket.” In this case, the basket is the same entity and the locations are your eggs.  In the multiple location scenario, you should consider the brother-sister subsidiary structure such that each location is owned in a brother-sister relationship (e.g. neither owns the other) and their common connection is simply the underlying company (or person) who owns each entity for each location. Because both locations have risk it is useful for each to have their own entity and not to own each other (as can occur in the parent-child subsidiary). When structured in a brother-sister relationship, the liability for each location is contained in each subsidiary entity and cannot run over into the other subsidiary entity (the sibling entity) or down to the owner (which may be you personally or your operational holding company).

For tax purposes, the brother and sister subsidiary income (usually single member LLCs) flows down to the parent or primary entity where a tax return is filed (usually an S-Corp). (See the diagram below for an illustration.)Diagram displaying the Brother-Sister Subsidiary structure

III. Adding a New Partner

Maybe you’re starting a new business or operation where you have a new partner involved. If this partner isn’t involved in your other business activities or your existing company, it is critical that a new entity be established to operate the new partnership business. If you have an existing entity where you run business operational income (e.g., an S-Corporation), then this entity may own your share of the new partnership entity (e.g., an LLC) with your new partner. Your share of the new partnership income flows through the partnership to your existing business entity where you will recognize the income and pay yourself. In this instance, your existing entity is the parent and the new partnership is a partial-child subsidiary. The new partnership entity will typically file a partnership tax return.

IV. California Caveat

Because of gross receipts taxes in California, you may use a Q-Sub entity model where the subsidiary entity is actually another S-Corporation and is called a Q-Sub. This is available only when the parent entity is an S-Corporation and can avoid double gross receipts tax at the subsidiary and parent entity level.

Make sure you speak to your tax attorney for specific planning considerations as there are asset protection and tax considerations unique to each business and subsidiary structure.

2014 Solo 401(k) Contribution Deadlines

Photo of a clock on a wall with the text "2014 Solo 401(k) Contribution Deadlines."I posted a comprehensive article last week about 2014 retirement plan contributions in general. However, as the year ends I wanted to highlight three important deadlines you must know if you plan to set-up a Solo 401(k) in 2014. A solo 401(k) is a retirement plan for small business owners or self employed persons who have no other full time employees other than owners and spouses. It’s a great plan that can be self directed into real estate, LLCs or other alternative investments, and that allows a the owner to contribute up to $52,000 per year (far more than any IRA). Keep in mind though that it is just for self employed persons and new business owners.

2014 Solo 401(k) Setup Deadlines

First, the 401(k) must be adopted by your business by December 31, 2014. Practically speaking, this means you should be starting soon (if you haven’t already) so that documents can be completed in time. If the 401(k) is established on January 1, 2015, or later you cannot make 2014 contributions.

Second, both employee and employer contributions can be made up to the company’s tax return deadline INCLUDING extensions. If you have a sole proprietorship (e.g. single member LLC or schedule C income) or partnership then the tax return deadline is April 15, 2015. If you have an s-corporation or c-corporation, then the tax return deadline is March 15, 2015. Both of these deadlines may be extended 6 months by filing an extension and the date to make 2014 contributions will also be extended.

Third, while employee and employer contributions may be extended until the company tax return deadline you will typically need to file W-2’s for your wages (e.g. an s-corporation) by January 31, 2015. The W-2 will include your wage income and any deduction for employee retirement plan contributions from your wage income will be reduced on the W-2. As a result, you should make your employee contributions (up to $17,500 for 2014) by January 31, 2014 or you should at least determine the amount you plan to contribute so that you can file an accurate W-2 by January 31, 2015.

For more details on the contribution deadlines, please visit my prior blog article here.

2014 Retirement Plan Contribution Deadlines: Start Planning Now & Don’t Get Left Behind

Photo of a clock on a wall with the text "2014 Retirement Plan Contribution Deadlines Start Planning Now & Don’t Get Left Behind."Retirement account/plan contributions are one of the most powerful tax strategies you can implement but you’ve got to make them by the deadline so that they can reduce this years tax liability. With the end of the year fast approaching, now is the time to make certain you are maximizing this important tax strategy for your 2014 tax planning. Please find below a table outlining the deadlines for 2014 retirement plan contributions according to your type of retirement account.  If you are self-employed, you’ll notice the deadline also may depend on the type of company you own (e.g. s-corp or LLC)  but also whether you are making contributions as an employee of your company and/or as the employer. First, let’s summarize the IRA contribution deadlines.

IRA Contribution Deadlines

Type of IRAContribution TypeDeadline Details
Traditional IRATraditional, DeductibleApril 15, 2015, Due Date for Individual Tax Return Filing (not including extensions).  IRC § 219(f)(3); You can file your return claiming a contribution before the contribution is actually made.  Rev. Rul. 84-18.
Roth IRARoth, Not DeductibleApril 15, 2015, Due Date for Individual Tax Return Filing (not including extensions). IRC § 408A(c)(7).
SEP IRA EmployeeN/A; employee contributions cannot be made to a SEP IRA plan.
Employer ContributionMarch 15/April 15th, Due Date for Company Tax Return Filing (including extensions).  IRC § 404(h)(1)(B).
Simple IRA Employee Elective DeferralJanuary 30, 2015.  IRC § 408(p)(5)(A)(i).
Employer ContributionMarch 15/April 15, Due Date for Company Tax Return Filing (including extensions).  IRC § 408(p)(5)(A)(ii).

 

In summary, for traditional and roth IRA contributions you have until the individual tax return deadline of April 15, 2015 to make 2014 contributions. SEP and SIMPLE IRA contribution deadlines are based on the company tax return deadline which could be March 15th if the company is a corporation and April 15th if it is a sole proprietorship or partnership. Keep in mind that this deadline does NOT include extensions so even if you extend your personal tax return filing to September 15, 2015, you still have a April 15, 2015, contribution deadline for Roth and Traditional IRAs.

401(k) Contribution Deadlines

Solo 401(k)Business StructureType of Cont.Deadline Details
401(k), including self-directed Solo 401(k) (plan must be adopted by 12/31/14)Sole ProprietorshipEmployee Elective DeferralContributionApril 15, 2015, contribution deadline is Due Date for Employer Tax Return (including extensions) but compensation must have been earned by December 31, 2014 and election should be made by December 31, 2014; IRS Publication 560.  Rev. Rul. 76-28; 90-105.
Employer Profit Sharing ContributionApril 15, 2015, Due Date for Company Tax Return Filing, including extensions, however employee compensation must have been earned by December 31, 2014.  IRC § 404(a)(6).  Rev. Rul. 76-28; 90-105.
S-CorporationOr C-CorporationEmployee Elective Deferral contributionMarch 15, 2015 (corporation filing deadline), contribution deadline is Due Date for Employer Tax Return (including extensions) but compensation must have been earned by December 31, 2014 and election should be made by December 31, 2014;  IRS Publication 560.  Rev. Rul. 76-28; 90-105.
Employer Profit Sharing ContributionMarch 15, 2015, Due Date for Company Tax Return Filing, including extensions, however employee compensation must have been earned by December 31, 2014.  IRC § 404(a)(6).  Rev. Rul. 76-28; 90-105
Partnership (e.g. partnership LLC)Employee Elective Deferral ContributionApril 15, 2015 (partnership return filing deadline), contribution deadline is Due Date for Employer Tax Return (including extensions) but compensation must have been earned by December 31, 2014 and Election should be made by December 31, 2014;  IRS Publication 560.  Rev. Rul. 76-28; 90-105.
Employer Profit Sharing ContributionApril 15, 2015, Due Date for Company Tax Return Filing, including extensions, however employee compensation must have been earned by December 31, 2014.  IRC § 404(a)(6).  Rev. Rul. 76-28; 90-105.

 

There are a few important things to keep in mind regarding 401(k) contributions.

401(k) Contribution Deadlines Can Be Extended

First, the contribution deadline for employer and employee contributions is the company tax return deadline INCUDLING extensions. So, if you have a solo 401(k) you can extend your company tax return and your contribution deadline is also automatically extended. For example, if you have a solo 401(k) plan adopted by your s-corporation, then your s-corporation tax return deadline is March 15, 2015, but that can be extended 6 months until September 15, 2015, upon filing an extension to extend the company tax return with the IRS. If you do this, you’d have until September 15, 2015, to make the 2014 employee and employer contributions. That being said, the employee contributions are taken from your salary/wages and if you make traditional 401(k) employee contributions those amounts are reported on your personal W-2 and reduce your taxable wages. The W-2 is effectively where your tax deduction for traditional employee contribution arises is it reduces your taxable wages on your W-2.  As a result, you’ll need to make or at least know the amount you intend to make for employee contributions by January 31, 2015 as that is the W-2 filing deadline for 2014.

New 401(k)s Must Be Adopted by December 31st

Second, if you are establishing a new Roth or Traditional IRA, you can create that new account at the time of the IRA contribution deadline. However, if you are establishing a new solo 401(k) plan, you must have the plan established by December 31, 2014. Because there are a number of documents and procedures required to create a new 401(k) plan, this is not something that can be left to the last minute and you should start immediately if you intend to open a 401(k) this year.

Make 2014 Contributions in 2014

And lastly, while the deadlines for most 2014 retirement plan contributions for IRAs and 401(k)s runs into 2015, to keep things simple and stress-free we recommend making 2014 contributions by December 31, 2014, when possible.

As you can see, the contribution deadlines vary depending on the type of account/plan but also on the type of contribution.  With respect to contributions to a self-directed solo 401(k), the contribution deadline also varies depending on the type of company you own that has adopted the plan.  Therefore, it is important that you understand these deadlines and don’t miss out on an opportunity to maximize your tax deductions.  For guidance on the contribution limits in 2014, please click here.

As previously stated, it is not too late to setup a retirement account/plan if you have not done so already.  The deadline to set up a 401(k) and to make contributions for 2014 is typically the last day of the year, although I wouldn’t wait until the last day or even the last week of the year to do so.  If you are interested in setting up a self-directed solo 401(k), please contact us immediately as we are helping clients establish these and so that we can get it set up before the end of the year.

When Does Raising Money in an LLC, Joint Venture or Partnership Violate Securities Laws?

We’ve all heard the buzz words of crowdfunding, PPMs, and IPOs, but there are less complicated ways to raise money and start a business and one of the most reliable and most used methods is that of partnerships or joint ventures.

If you ‘re raising money from others in an LLC, partnership, or joint venture, you must take specific precautions in structuring your documents so that the investment of money from any member, partner, or joint venturer does not constitute a violation of federal or state securities laws. Failure to comply with the securities laws can result in civil and criminal penalties. Many real estate investments, real estate developments, and emerging companies rely on numerous strategies to raising capital that are outside of publicly traded stock and that do not require registration with a state securities division or the federal Securities and Exchange Commission. This article addresses those strategies and outlines some of the key issues to consider when raising funds through an LLC, partnership, or joint venture arrangement. This article addresses the legal considerations that should be analyzed when bringing in “cash partners” or “investors” into your LLC, partnership, or joint venture.

Is the LLC Member, Partner or Joint Venturer Contributing More Than Just Money?

The courts have widely held that an investment in an LLC, joint venture, or partnership is a security when the investor is investing solely cash and has no involvement, vote, or say in the investment. In these instances where the investor just puts in cash (sometimes called “silent cash partner” arrangements), the investment will likely be deemed a security. In a famous securities law case called Williamson, the Fifth Circuit Court of Appeals held that a joint venture contract investment is a security if the investor has little say or voting power, no involvement in the business or investment, and no experience that would provide any benefit to the business or investment. Williamson, 645 F.2d 424. As a result, to avoid triggering these factors and having your investment or business deemed a security we strongly recommend that all investors in Joint Venture agreements, LLCs, or partnerships have voting rights and that they participate in the key decision-making functions of the investment or business. Investors do not have to be part of the management team but they do need to have voting rights and need to have real opportunities to use those voting rights. For example, they could have voting rights on incurring additional debt, on management compensation, and/or on buying or selling property.

Don’t Give Yourself Unlimited Control as Manager

In most LLCs with cash partners, the person organizing the investment and running the operations is often the manager of the LLC, partnership, or joint venture and has the ability to bind the company or partnership. When making this selection as the manager, it is key that you do not give yourself unlimited control and authority. If you do give yourself unlimited control as manager, your investors may be deemed to have purchased a security since their voting rights will have been extinguished by placing to much control and power in the manager/management. What is recommended is that the members have the ability to remove the manager by majority vote and that the manager may only make key decisions (e.g. incurring debt, selling an asset, setting management salaries, etc.) upon the agreement and majority vote of the investors. While key decisions and issues should be left to the members, day to day decisions can be handled by the manager without a vote of the members/investors.

Don’t Combine Too Many People Into One LLC, JV or Partnership

The Courts have consistently held that even if an investor is given voting rights and has an opportunity to vote on company matters that the investor’s interest can be deemed a security if there are too many other investors involved in the LLC, JV, or Partnership. Holden, 978 F.2d 1120. As a general rule of advice, you should only structure investments and partnerships that include 5 or less cash investors as the securities laws and the involvement of more individuals than this could potentially cause the investment to be deemed a security. When there are more than 10 investors it is critical for clients to consider structuring the investment as a Regulation D Offering and that they complete offering documents and memorandums and make a notice filings to the SEC. Many people refer to this type of investment structure as a PPM.  When there are a lot of investors involved, a Regulation D Offering provides the person organizing the investment with exemptions from the securities laws and can allow someone to raise an unlimited amount of money from an un-limited amount of investors.

In sum, there are many factors and issues to consider when raising money from others in an LLC, JV, or partnership and it is crucial that you properly structure and document these investments so that they can withstand thes challenges of securities law violations. For help in structuring your investments please contact the law firm at 602-761-9798.