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Should your S corporations be in a holding company?

The way the economy is going, a lot of entrepreneurs are going to be looking at taxable losses for 2009.Blog   Those who run multiple businesses in separate S corporations should ponder an S corporation holding company before year-end.

S corporations generally don't pay their own income taxes.  They report their income on a Schedule K-1 issued to their owners, and the owners pick up the K-1 income on their 1040s.  S corporations are popular because they can distribute their earnings without further income tax, in contrast with double taxed C corporations.  They also can enable their owners to reduce their income with K-1 losses.

Unfortunately, shareholders need to have basis in their S corporation stock, or in loans they have made to their S corporations, for their K-1 losses to be deductible.  Entrepreneurs with multiple S corporations might find themselves with plenty of basis in a profitable S corporation, but no basis at all in a money-losing corporation.  That means they might pay tax even though they didn't actually make any money:

Example: Todd owns 100 percent of S corporations Razor Corporation and Market Street Brewing Company.  Razor has $1 million taxable income, while Market Street has a $1 million taxable loss in 2009.  At the beginning of the year, Todd has no basis in either company.  He makes no distributions or cash contributions to either company in 2009.  At year end, he has $1 million in basis in Razor, because undistributed taxable income increases the basis of S corporation stock.  Unfortunately, he still has no basis in Market Street, so his losses only carry forward until he either contributes basis to Market Street or it generates its own taxable income.

 Even though between the two companies Todd has no taxable income, he has to report $1 million of income from Razor without deducting any loss from Market Street.

A far better solution would have been to have the S corporations all under a single roof in an S corporation holding company.  For example, Todd could set up a new S corporation -- we'll call it Todd Holdings -- and contribute his stock in both companies to it.  The old S corporations would elect to be "Qualified Sub-S Subsidiaries," or "Q-Subs," of Todd Holdings.  Todd could then count the basis of the corporations together, enabling him to use the $1 million of year-end basis in Razor to take his Market Street loss.

Setting up holding companies is normally uncomplicated, but it can cause huge tax problems if not done properly.  Don't mess with your corporate structure without consulting a competent tax advisor.  If you get it set up by year-end, a holding company should provide the same benefit as if it were in place the whole year.

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How can you go about choosing a tax advisor who is actually competent, though. I mean, do you ask for references, or try to find someone that someone you know has used? Whats the best way?

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