Subsidiaries are companies owned wholly or in part by another company. The parent company holds at least 50 percent of the voting stock, and thus, controls the subsidiary’s operations. Parent companies create new subsidiaries to help expand their operations and take advantage of the tax benefits. Although parent companies often include the financial details of subsidiaries in their annual returns, subsidiaries must obtain distinct employer identification numbers.
Subsidiaries in General
If the parent company sets up subsidiaries and owns a stake of at least 80 percent in each, it can file a consolidated federal tax return. This return is a combination of the parent company’s and subsidiaries’ profits and losses. This allows the companies to offset losses against the combined profits. The process can help reduce the taxes applicable on any one company with a major profit. Some states also have laws that allow companies to pay taxes on income generated only within the state and not on operations outside the state.
Subsidiaries of Tax-Exempt Companies
If a tax-exempt organization sets up a subsidiary, the new company must have an identity of its own, and therefore must apply for a federal tax identification number, or employer identification number. The subsidiary must have its own bank account, and the organizations must keep distinct financial statements. The subsidiary must file and pay all the yearly state and federal taxes applicable on the income it generates, and it must also withhold taxes and comply with laws that apply to it as an employer if it has employees.
Parent companies might set up franchisees or Qualified Subchapter S subsidiaries in states other than the ones where they conduct their operations. In this case, they must comply with the laws and regulations of the state where the subsidiary is domiciled. These laws may or may not differ from federal laws. For example, in California, parent companies must include details of the subsidiary’s income, deductions and credits on the parent’s annual return.
Subsidiaries also might operate in foreign countries, and therefore, need to work according to the laws of the foreign country and pay taxes accordingly. While the subsidiaries pay taxes in the foreign country, the parent pays taxes in the United States. If the parent reinvests the foreign subsidiary’s profits back into that subsidiary, they can defer paying taxes on that income. This is because the parent pays taxes only on money returned to the U.S. and need not pay taxes on the reinvested portion of the profits.
Special Purpose Entities
Companies might also set up special purpose entities such as limited liability companies or limited partnerships. These are companies whose owners’ liability is limited to the assets of the company. If the company incurs losses, creditors can’t seek settlements from the owners personal assets. Because parent companies control these entities, they are responsible for the taxes and any debts they might incur.
- Journal of Accountancy: Is a Subsidiary in Your Future
- Internal Revenue Service: Employer Identification Number
- ASAE: Forming and Operating Subsidiaries and Related Entities
- State of California Franchise Tax Board: Frequently Asked Questions: Qualified Subchapter S Subsidiaries (QSub)
- Arizona Department of Revenue: Combined or Consolidated Return Affiliation Schedule
- Tax Foundation: The Economics of International Taxation
- Federal Deposit Insurance Commission: Real Estate - Subsidiary structured as limited liability company
- NOLO: Limited Liability Company (LLC) FAQ
- Arizona Department of Revenue: Arizona Corporate Tax Ruling
- Arizona Department of Revenue: Arizona Form 122