What is a Holding Company?
A holding company is formed the same way any other company is. Rather than directly engaging in operations, it instead owns and controls other companies. It avoids operations specifically to avoid the resulting operational risks and liabilities.
Both Wyoming LLCs and Corporations may act as holding companies. However, only LLCs provide charging order protection - not corporations. For this reason, we advise using an LLC to hold corporate shares if extra protection is desired.
Separate valuable assets from operational liabilities and personal creditors.
The holding company acts as a bank which loans to subsidiaries when needed.
Through loans, leases, royalties, etc. income is shifted to no tax jurisdictions.
Who Uses Holding Companies?
Holding companies are used across a wide variety of industries. For example, real estate investors, e-commerce s, trucking companies and anyone else with significant assets who could be placed at risk.
Type of Entity
The decision of what type of entity to create is between a limited liability company (LLC) and a C-Corporation.
[Note that an S-Corp is not an entity type—it is a tax election. Many people get this confused. An S-Corp is an LLC or C-Corp (or other) that has elected to be taxed under Subchapter S of the Internal Revenue Code. More on this below.]
C-Corp: The main attributes of a C-Corp is that it is made up of ownership units called shares or stock and has two levels of taxation. A C-Corp should mainly be used for two reasons: if there is large net income that needs to be retained in the corporation at low tax rates or for employee equity compensation purposes.
Close Corporation: A Close-Corp is unique to Wyoming. This entity does away with most corporate formalities. There is no board of directors, regular or annual meetings, and there are reduced reporting requirements to shareholders. This reduced governance is attractive when there is one owner, or a small group of tight knit owners who trust one another.
Limited Liability Company: LLCs have flow through taxation meaning that profits and losses flow through the entity and are reflected at the individual (owner's) level. There is no stock in LLCs. LLCs have member interests. These interests are largely defined by contract (in this case, the LLC's "Operating Agreement.") Members-to-be receive an interest in return for contributing cash, property, or services to the LLC. The amount members contribute or receive as distributions from the LLC are reflecting on the member's "capital account." This will show how much their membership interest is worth.
Close Limited Liability Company: This entity is unique to Wyoming. It has the same asset protection and tax benefits as a regular LLC. It does not, however, have to hold regular or annual meetings. This means less corporate governance and a reduced chance of having the veil pierced. More on that below.
There are membership transfer restrictions where a member who wishes to sell must provide right of first refusal to existing members. This prevents an outside individual or group from unknowingly seizing control of the LLC. This setup is ideal for Single Member LLCs and those owned by families or other tight-knit groups. Finally, a Close LLC may have no more than 35 members.
For asset protection, it is important to:
- separate the company from the owners;
- separate the ownership of a property from its management;
- separate properties from one another;
- and be as anonymous as reasonably feasible.
There is no 100% bulletproof plan to avoid personal liability or to protect assets. What we will do is make it as difficult as possible for anyone to reach you from a practical standpoint (they don't know who you are) and from a legal standpoint (a legitimate LLC will separate you from the entity, and one entity from another). The two models used for separating holdings and operations are the sister-sister model (where each entity is entirely separate from each save for some contracts and dealings) and the parent-subsidiary model (where the parent owns the subsidiary.)
Choosing a State
Any entity should be incorporated in either of four locations: your home state, Delaware, Nevada, Wyoming or New Mexico.
Considering a number of factors: taxes, fees, regulatory environment, charging order protections, and privacy Wyoming is the most beneficial situs for your entities with Nevada as a close second.
Both Nevada and Wyoming have no corporate, franchise, nor personal income tax. However, Wyoming has much lower fees: $100 initial formation fee + $50 for annual fee. Nevada's fees are hundreds of dollars and are consistently raised.
Both Nevada and Wyoming are favorable towards corporations and limit veil piercing. Wyoming also allows for single member and multi-member LLCs to have charging order protection. With charging order protection, a creditor of a debtor-LLC member will be limited to the debtor's share of distributions only and will not be able to receive voting or management rights. A charging order is a weak remedy as there are numerous actions which can be taken to counteract it.
Wyoming and New Mexico are notorious for corporate privacy. While Nevada affords a fair amount of privacy for corporations, it does, however, list the name of various officers and directors. Wyoming and New Mexico provide more privacy for owners in this regard.
The location of your management company will need to be in the state where you are transacting business. If you chose Wyoming for the management company, then it would be transacting business elsewhere and would otherwise have to qualify as a foreign entity any way (see below about qualifying as foreign entity.)
Due to these reasons, Wyoming is the ideal location for your top level holding company and real estate holding entities, while the state(s) where you are managing property will require their own local entities.
These are the documents that will be crucial to forming your entities:
Articles of Organization/Certificate of Formation: This is a document filed with the Secretary of State and contains basic information including company name, contact address, and registered agent. The company is created when this document is approved by the State. The information provided is intentionally minimal as the document is a public record.
Operating Agreement: LLCs have operating agreements. For C-Corps, their similar document are bylaws. An operating agreement is the governing document that describes the internal rules of the company. It is not public and is not filed with the state. This document concerns membership rules, dispute resolutions, meeting schedules, etc. Even if the LLC is a Single-Member LLC, you still need this.
Minutes of the First Meeting: This is the first meeting of the members of the LLC. The members accomplish certain tasks such as identifying the managing member and approving certain resolutions.
Employer Identification Number: A number similar to a social security number must be assigned to the LLC. This is called an Employer Identification Number (EIN.) It is received by applying to the IRS.
Agreements between Holding and Management Companies: As mentioned, the holding company should hold the business assets and should license, lend, lease, etc. these assets to the management company. In return the holding company will give a management fee. These agreements should be on arm's length terms.
Registering As A Foreign Entity
You may be wondering if the Wyoming entity is able to do business in your home state.
If an entity "transacts business" in another state, it must qualify in that other state as a foreign entity. This essentially means they have to file some forms and pay any fees due.
In most states, except, for example, California, these are some listed activities that do NOT constitute "transacting business"—owning real or personal property, maintaining a bank account, holding a meeting of officers, etc.
In other words, the holding company in Wyoming WILL be able to do the things you need it to do (hold real estate located in another state) and you will not need to file as a foreign entity at this time.
Holding Company Example
Hotels are an easy way to conceptualize holding companies. A hotel could be owned by a single company. This would be unwise, though, as a valet accident could potentially affect the land, buildings, cash and other assets.
To isolate risk, various entities would be formed with a holding company on top. The companies below would hold the assets and engage in operations. For example, land would be owned by one company, the structure another, with a third managing the property.
Operations may be further divided with restaurants, valet, maids, maintenance and other roles being filled by their own entities. This separation prevents an accident in one part of the hotel from affecting the whole operation.
Sister-Sister Set Up
Consider a company which sells hats, candles and health supplements. Each is likely to operate under a different brand. Rather than forming an LLC with DBAs, it is better to form multiple entities. If there is significant inventory, then you may form an LLC solely for holding and managing inventory.
Establishing One Company
Operating a single LLC with multiple revenue streams makes your creditor's lives easier. Assets held by a company which has operational liabilities are easier to take. An accident with a candle could bankrupt every product line. Or, if there's no accident, but the company does well instead, then mixing revenue and expenses between lines makes reaching a valuation harder.
Separating product lines makes each LLC bankruptcy remote. It also protects valuable assets, such as cash and inventory, in the holding company. A credit event with an operating company may lead to its closure, but operations continue as usual with the other companies. The holding company is allowed to file what is called a consolidated report. This means you will not be required to keep books and file separate returns for each company. Everything can be consolidated within the holding company's filing.
Real Estate Investors
Real estate is inherently risky. Accidents, treasure hunters and lapses in insurance are just some of the risks investors face. Beyond the properties, real estate investors also face personal risks which in turn risk their properties.
Many investors stop at forming an LLC and placing their rental property inside it. This presents three problems:
- An accident at the property could easily lead to its loss.
- There is little to no protection from personal creditors.
- Most states don't allow anonymity.
The solutions to the above problems will be determined by your goals. For each person, there comes a point where the added complexity outweighs any extra benefit.
The next step is forming a Wyoming LLC holding company. This Wyoming LLC owns LLCs in other states which own and manage properties. This results in little increased complexity and brings significant benefits. Your Wyoming LLC has charging order protection which means personal creditors cannot seize your properties. Cash generated by the properties can be flowed into the holding company for safe-keeping, and the double LLC prevents operational creditors from seizing personal assets.
Equity Stripping: The Wyoming company may loan the down payment to the operational company. A second lien is then placed on the home. This strips the operating LLC of its equity in the home and removes any potential pay day for creditors.
Property Management: Wyoming LLCs are also used to hold the property. The property is then managed by a local property management company. You may or may not control the management company. The property management company is in charge of maintenance, operations and signing contracts. This isolates operational risks with the management LLC rather than the LLC holding the property.
Land Trusts: Revocable trusts can be formed to hold real estate in states which don't otherwise allow anonymous ownership. Hiding ownership makes it difficult to link your properties together and makes you less of a target. An LLC is the beneficiary of the trust.
The above strategies may be used separately or together. They may also be combined with asset protection trusts and 401ks. Stopping with a holding company is common, with additional steps being taken less frequently.
Wyoming is the only state which specifically protects single member LLCs. This helps not only single owners, but less obviously holding companies since subsidiaries are often single member LLCs. Other states make it easy for a judge to assign operation liabilities to the holding company. Wyoming's laws don't allow this so long as you obey corporate formalities.
Historical Context & Summary
Holding companies were previously the domain of large, often international, corporations. Today, their adoption has spread to e-ecommerce stores and real estate investors - to name a few industries. Driving this are the reduced costs of new company formations and the evolution of U.S. business law to encourage such planning.
Holding companies may be set up in any state, but they are more effective in traditional havens such as Wyoming. This is due to laws which strengthen protections from both personal and corporate creditors while lowering taxes.