Setting up your entrepreneurial endeavors using a parent-subsidiary structure helps manage the risks associated with different business projects. However, managing interlocking businesses is more complicated than owning each business in an individual capacity. The subsidiary's profits must go through the parent company before any of the cash ends up in your pocket.
A subsidiary is a corporation or limited liability company that is owned by another company, known as its parent. The parent company is typically a corporation, but it can also be another LLC. In a small-business context, the parent usually owns 100 percent of the subsidiary, but it's also possible for the parent simply to own a majority interest.
Generally, a business manages its finances on a yearly basis by subtracting expenses from revenue to arrive at net income, then paying taxes on net income to determine how much it has left over in profit. The business then can distribute all or a portion of profits to its owners. A corporation's board of directors can vote to distribute all or a portion of the company's profits to shareholders as dividends, while an LLC can distribute profits to members based on the way the company has chosen to be taxed.
Whether or not the subsidiary is organized as a corporation or an LLC, the parent is its owner. The parent is either the sole (or majority) shareholder or member and is entitled to profit distributions from the subsidiary. Further, the parent has substantial control over the decision to distribute the subsidiary's profits. If the subsidiary is a corporation, the parent-shareholder gets to select the board members who make the decision regarding dividend distributions. Likewise, if the subsidiary is set up as an LLC, the parent controls who is hired to run the company on a daily basis.
A subsidiary doesn't have to wait to the end of the year to distribute profits to its parent. Corporate subsidiaries can choose the timing of dividend payments, such as paying them quarterly. LLC subsidiaries can make a distribution on any reasonable schedule. In both instances, the payments can be based on profit projections.
If your subsidiary is organized as an LLC, the way profits flow to the parent company can depend on the subsidiary's tax elections. An LLC subsidiary wholly owned by a single corporate parent is considered a single-member LLC by the Internal Revenue Service. A single-member LLC can choose to be taxed as a disregarded entity, where profits and losses are passed through to the parent instead of reported by the LLC, or a corporation. LLC subsidiaries that elect status as disregarded entities are treated as a division of the parent for tax-reporting purposes, so the parent has more direct access to the subsidiary's profits.