You may already know that it's possible to set up a limited liability company (LLC) and then create subsidiary LLCs for each business you’re operating. But is this really a good idea? Is it even legal for one LLC to own another one?
Whether this sort of structure is a good idea for your business depends on the risks you’re exposed to and your willingness to take on additional administrative tasks.
The Legality of Parent LLC's
As for the legality of ownership, an LLC is allowed to be an owner of another LLC. LLC owners are known as “members.” LLC laws don’t place many restrictions on who can be an LLC member. LLC members can therefore be individuals or business entities such as corporations or other LLCs. It is also possible to form a single-member LLC whose only owner is another LLC.
Why Would an LLC Own Another LLC?
Business owners who have several lines of business often form a parent LLC and subsidiaries to minimize their risks. Because of the liability protection provided by LLCs, if one part of the business fails, it won’t jeopardize the others.
Real estate investors and developers, movie studios and other businesses that have multiple ventures with different risks frequently form parent and subsidiary LLCs. Businesses that have particularly risky operations, such as certain types of construction firms, might consider having a parent LLC, a subsidiary LLC to hold assets and take care of administration, and another subsidiary LLC to be in charge of operations.
To see how this works in real life, suppose you own three apartment buildings. Each of those buildings presents a risk of lawsuits from tenants and their visitors. Each also carries a risk of financial failure. To avoid having one building’s problems affect the others, you might choose a parent-subsidiary LLC structure.
The parent LLC would oversee general administrative tasks, while three subsidiary LLCs would own and manage each of your apartment buildings. Each of these LLCs would be a single-member LLC with the parent LLC as its only owner.
Now suppose someone is seriously injured at one of your apartment buildings and sues that building’s LLC. The LLC could potentially lose all its money and assets. But your other two subsidiary LLCs, the parent LLC, and you personally are safe from liability. By contrast, if you had lumped all three buildings into one LLC, you could lose your entire rental business as a result of that one lawsuit.
Disadvantages and Limitations of Parent and Subsidiary LLCs
Creating and operating multiple LLCs is more time consuming and expensive than just having one LLC. Setting up an LLC involves preparing and filing articles of organization and creating an LLC operating agreement. Every state charges a filing fee. If you set up multiple LLCs, you will have to file LLC forms and pay a fee for each one. Each LLC will need to keep its own records and maintain its own bank account, payroll and tax documents.
Setting up a parent-subsidiary structure will not always allow you to avoid liability. If the parent LLC is sued, then all of the parents’ assets, including all its subsidiaries, are at risk.
You can also personally be at risk if you are sued for your own personal negligence or if you are sued because you signed a personal guarantee on a loan.
Why an LLC and Not a Corporation?
Corporations traditionally pay corporate income tax and their shareholders are taxed on distributions they receive. The only way a corporation can avoid this “double taxation” is to elect S corporation status. However, S corporations have strict eligibility rules, and they cannot be owned by other corporations or LLCs.
Like S Corporations, LLCs enjoy pass-through taxation: there is no corporate income tax, and profits pass through to the owners’ personal tax returns. If you want to set up subsidiary companies and have pass-through taxation, you must set them up as LLCs, because they will not qualify to be S corporations.
Creating parent and subsidiary LLCs is one way for business owners to minimize their liability risk. Whether the strategy is right for you will depend on whether the protection you’ll receive justifies the additional administrative time and money required. A lawyer can help you decide.