Why A Holding Company Builds Wealth

Any time you encounter an investment concept that you have never heard of before, you can be pretty sure that it exists for at least one of the three reasons: (1) tax minimization; (2) marketability; or (3) liability. The use of the holding company structure is no different. A holding company is an investment tool of the wealthy that is useful if you want to lower taxes, transfer assets easier, or avoid liability.

For instance, let us that over the course of your life, you become one of those secret millionaires in Quincy, Florida that makes a lifelong fortune by investing in Coca-Cola stock. By the time you are middle-aged, you find yourself owning 10,000 shares of KO that pays out $14,000 in dividends every year.

Rather than reinvest directly into more KO shares, you decide that you want to buy a duplex to diversify and start collecting rental income.

By the time 2026 comes around, you find yourself using those KO dividends to pay off the mortgage on that $200,000 duplex and you find yourself receiving $1,000 per month in rental income from your duplex tenants while the KO dividend has doubled to $2.80 per share and now pays out $28,000 in dividends to you every year.

You find yourself sitting on $40,000 in cash flows from your Coke investment and duplex and you turn your eye towards estate planning. If you have two kids, and you know that gift tax laws permit you to transfer $14,000 in value to them per year without any tax consequence, you wonder what would be an efficient way to begin the process of transferring those cash-generating assets to them.

Sure, you can directly transfer KO shares to them, but it the duplex is a little bit more difficult—how can you make this gradual transfer in a coherent manner?

This is where a holding company comes in. It can be an LLC or a corporation—you get to decide—but it is set up to “hold” other assets so that you can package different businesses together and transfer them more easily and take advantage of the tax code.

So imagine as part of our estate planning that our investor decided to create an LLC for those Coca-Cola shares and the duplex. He fills out the paperwork with his secretary of state, sets up a bank account to receive the Coca-Cola dividends and rental income (this step is critical otherwise you are executing a fraudulent transfer which will cause your holding company to be a disregarded entity for liability and investment purposes!), and then sets up by laws / creates an operating agreement that will outline the rules for the holding company.

In our case, our investor might decide to name his holding company “Jones Family Holdings LLC” and divide it up into 50,000 units (this is the functional equivalent to a corporation creating shares). The number of units that you choose is up to your discretion, but you want to divide your holding company up into enough pieces so that it is liquid and easily marketable to meet your transferring needs.

In our example, let’s assume the Coca-Cola stock trades at $80 per share in 2026 and the value of the duplex is appraised at $300,000. Those 10,000 shares of Coca-Cola have a value of $800,000 and the duplex adds $300,000 making the holding company that we called “Jones Family Holdings LLC” worth $1.1 million.

Because Mr. Jones decided to divide the holding company into 50,000 units at the outset, each unit of Jones Family Holdings LLC is worth $22 per unit. Basically, he has found a way to make the generally illiquid real estate holding (the $300,000 duplex) much more marketable and transferable while also making it part of a parent asset that also includes Coca-Cola stock.

For wealthy families, these holding company arrangements are useful for massaging the effects of the estate tax when they die. Why? Because each individual is permitted to transfer $14,000 per year in value to any particular person under the annual gift exclusion. If the 50,000 units of Jones Family Holdings LLC is owned by both Mr. and Mrs. Jones, then they can each transfer $14,000 to each of their two kids. Johnny can receive $14,000 worth of the holding company stock each year from his dad without any gift tax cost, Johnny can receive $14,000 worth of the holding company stock each year from his mom without any gift tax cost. And the same applies for his sister Suzie, who can also receive $14,000 worth of Jones Family Holdings LLC from each parent each year.

You can see how this becomes a great tax planning and marketability tool. With the units valued at $22, each kid can receive 636 units from each parent each year.

Two parents, two kids. And $56,000 gets transferred without taxes each year by using a holding company to make your pre-existing assets much more marketable.

At the end of the year, Mr. and Mrs. Jones will have given away 2,544 units of Jones Family Holdings LLC. They will still have 47,456 units of the holding company. Meanwhile, Johnny and Suzie each own 1,272 units of the family’s holding company. And next year, the family can transfer $14,000 again.

A few years later, though, Coca-Cola might be trading at $120 per share. And the price of the property may simultaneously increase. By engaging in the transfer of the holding company stock as soon as possible, Mr. and Mrs. Jones are minimizing the possible effects of the estate tax when they die. Thirty years from now, who knows how valuable the Coca-Cola stock and the duplex will be. Who knows what the estate tax will be. By giving the kids a few hundred units each year, the parents are reducing the gross size of their taxable estate while gradually giving their kids ownership of an asset in a way that minimizes taxes. They won’t have to pay any taxes related to the acquisition of holding company stock, but will only have to pay taxes that are the regular part of an LLC owner’s expenses which can be paid through the LLC (such as the 23.8% dividend taxes that would turn those $28,000 in Coca-Cola dividends into a required tax payment of $6,664 which would have $21,336 actually remaining as the net-of-cash leftover).

Holding companies also make it much easier for the family to declare distributions on their LLC assets. Assume that a year’s worth of rental payments from the duplex were sitting in the account as well so you had $12,000 mixing with $21,336 from their ownership of Coke stock.

Mr. Jones sees the $33,336 sitting on the balance sheet of the holding company, and thinks it is sitting on too much cash. He think the business only needs to keep $15,000 on hand because it is so simple and only requires meaningful capital outflows for property taxes and duplex repairs.

He can declare a cash distribution of $18,336 for the unitholders of his holding company. With 50,000 units outstanding, each unit stands to collect a payment of $0.36672. Mr. and Mrs. Jones own 47,456 units, so they get together a check from the family holding company for $17,403. Johnny owns 1,272 units, so he gets a $466 dividend. And Suzie collects the same.

An added advantage of using a holding company is that it is a creature of contract so the terms can be modified. For instance, you might wonder: Can the kids take over control and, say, demand that the Coca-Cola stock be sold once they both control 25,001 more of the units? No, you can avoid power battles by crafting an operating agreement for the family holding company that says something like “So long as Mr. Jones continues to own at least 1 share of Jones Family Holdings LLC, he retains full management control of the holding company’s assets unless agreed to otherwise in writing.” Basically, this gives Mr. Jones the authority to transfer nearly all of the economic power to his kids over the course of his lifetime while retaining control of the underlying assets so he can raise the rent on the duplex as he sees fit and make sure that the KO shares are not sold.

As for liability protection, a holding company does not offer any protection when it only holds publicly traded stocks. If the Jones Family Holdings LLC only held shares of Coca-Cola and Johnson & Johnson, you wouldn’t get extra liability protection because publicly traded stocks already have legal liability. Now, let’s assume that the duplex was held as a sole proprietorship originally.

If that were the case, Mr. Jones was exposing himself to the risk of personal liability if he had to pay for a slip and fall or something like that (the existence of expected insurance arrangements are beside the point, as that is just one way of servicing your personal liabilities). Once the duplex was put inside the holding company, it now received the protection of limited liability so that no unitholder in the Jones family would be personally liable for expenses arising from the duplex—though liability from our slip ‘n fall case at the duplex could attach to other holdings if it did not individually contain limited liability protection.

For example, if a tenant in the duplex received a $50,000 legal judgment to pay medical expenses from the slip ‘n fall, and the duplex was a sole proprietorship put inside a holding company, the Jones Family Holdings LLC entity would be responsible for the payment and would have to sell off $50,000 worth of Coca-Cola stock to make the tenant whole. However, if Mr. Jones put the duplex in an LLC, and then added it to the family holding company, it would not be able to reach over to the Coca-Cola assets. If something caused the duplex investment to go under, it couldn’t take down the KO stock with it.

Basically, a holding company protects its owners from personal liability. But it does not automatically protect the other assets within the holding company unless they are each separately wrapped up in a limited liability holding structure of their own.

The last advantage of a holding company is that you can issue new shares and borrow against the assets in a holding company. For instance, let’s say Mr. Jones set this up earlier in life and had a third kid. Instead of giving up 1,272 of his own units, he could keep what he has and issue 1,272 new units to his child so that the Jones Family Holdings LLC now has 51,272 units. You have the power to dilute the holding company just like you do with a regular common stock.

You can also borrow against it. Let’s see Mr. Jones wanted another duplex and wanted to use the Coca-Cola stock and existing duplex as the collateral for the loan. He could buy a $300,000 property within the holding company by taking on debt that Jones Family Holdings LLC must repay. If he fails to repay it, he would have to liquidate the Coca-Cola holding, but personal liability because the family holding company would be responsible for the collateral on the loan.

I used Coca-Cola and a duplex in my example of the types of assets that a holding company might include, but those were just examples to show that you can put both operating businesses and passive investments inside a holding company. Heck, you could put book royalties or art inside of a holding company. There is no limit to the types of assets allowed in a holding company—it is all about providing a way to bundle assets together to make them more transferable to others, usually with an eye towards minimizing taxes and reducing liability.

Originally posted 2017-01-02 17:33:30.

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