Holding Company and Operating Company

By Jason Watson, CPA
Posted February 22, 2020

This is one of the most common situations where you own two entities that do business between themselves. For example, you are a typical poor accounting firm with the usual high maintenance clients, and you feel that everything would be better if you also owned your own office building. You would create an LLC as the holding company which owns the building, and another LLC (and probably taxed as an S Corp) for the operating company.

This arrangement can also reduce self-employment taxes or payroll taxes since this conduit changes the color of money. Huh? Your accounting firm’s income is earned income, taxed both at the self-employment tax level (or payroll tax level) and the income tax level. However, you reduce this earned income by the amount of rental expense and that subsequent rental income on the other end is considered passive, and only taxed at the income tax level. Beauty. You must have a lease and the rent must be market rates; usually a rent appraisal from an independent appraiser will suffice.

The rent appraisal is also a good idea in the expansion of ownership. For example, Jason and Tina Watson own the building that WCG leases. As WCG expands its ownership to other partners, the rent payment to Jason and Tina needs to be above reproach; ergo, a rent appraisal. This reduces office politics and hurt feelings.

Jason Watson, CPA, is the Managing Partner of WCG, Inc., a progressive Colorado Springs tax and consultation firm.

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Taxpayer’s Comprehensive Guide to LLCs and S Corps