If you’re looking to expand your construction business into a different type of work, sector, or location, one way to do so is through a subsidiary. A subsidiary is a separate business entity that your primary construction firm still owns. Using a subsidiary can have legal, tax, and operational benefits, though there are drawbacks. Here’s how this strategy works and when it could be worth using.
How does a subsidiary work?
A subsidiary is a separate corporation or other business entity with its own management team. However, your primary business owns a majority of this other company, at least 51%. That gives you control over the subsidiary’s board for company decision-making and strategy. In this arrangement, your main business is known as the parent company, while the sub-company is the subsidiary.
For example, Instagram and WhatsApp are subsidiaries of Meta (Facebook). The subsidiary sub-companies still run as separate organizations, but ultimately, they are owned by Meta, making the major long-term decisions as the parent company.
What are the legal and tax benefits?
A subsidiary combines legal protection with tax benefits. Let’s say you are trying to launch a new construction business different from your current organization. For instance, you’d like to expand from commercial construction into residential construction. Chances are the new venture would face losses as it takes time to get off the ground.
If you ran everything under one company, you’d be able to deduct all losses from the new venture against the profits of your existing business. However, your company would also be fully responsible for paying any losses and debts from this other business. If the other business runs into financial trouble, it could hurt the credit rating of your established business and your ability to borrow. Additionally, your main construction business would be liable for any legal issues from the new venture.
If instead, you set up a new company with no connection to your existing firm, you protect your main business against the liabilities and problems of this other venture. However, you wouldn’t be able to claim their losses to reduce the taxes on your other profits.
A Combination of Benefits
Under a subsidiary, you get both benefits. For federal taxes, your main construction company can deduct the losses from a subsidiary against its other profits, provided your parent company owns at least 80% of the subsidiary.
You also get an extra layer of legal protection in case the subsidiary struggles or fails. This structure makes it harder for creditors to go after your primary firm to pay losses and debts from the subsidiary. Your main firm isn’t liable for lawsuits against the subsidiary, making it an ideal tool for construction risk management.
Are there any drawbacks?
There are some possible drawbacks to using a subsidiary. First, you must pay legal and accounting fees to set up another business. You must also manage multiple tax returns versus just doing everything under your existing business and tax return.
Since a subsidiary has its own separate management, this creates bureaucracy in the chain of command and can slow down decision-making. While you ultimately make the decisions for the subsidiary, it may take longer to communicate and make changes versus how you’re used to handling everything in your current firm.
If the new venture goes bankrupt, creditors may still be able to go after your main business for payment, provided they can prove you ran everything essentially as one organization. Still, they would need to sue through bankruptcy court.
What are the reasons to create a subsidiary?
Some common reasons that your company may want to consider a subsidiary include:
This strategy can work well if you’re launching a new venture and are worried about whether it will succeed. Since a subsidiary is a separate company, there’s a legal and financial separation between it and your leading construction firm. On the other hand, if you run the new venture as part of your main construction firm, it would be fully responsible for any losses and debts.
A subsidiary could make even more sense if the new venture has much higher legal risk, like construction work involving dynamite. Then, you could do all that work under a subsidiary to protect your main firm against potential lawsuits.
Diversify the Business
Another reason to use a subsidiary is to expand into a new sector. That new area could require different strategies and planning. Splitting everything into two smaller, separately managed organizations that you own could be more efficient for operations and meeting construction workforce challenges. At the same time, you still keep the tax benefits as if you had run everything as one large company.
There could be other financial benefits to using this approach. For example, you plan to run a heavy highway construction business and an equipment company. If you run them as two separate entities, your construction business could pay to lease equipment from the equipment company.
This creates an extra deduction for your established construction business while moving income to your equipment company, which is helpful if it’s in a lower tax bracket. You wouldn’t be able to use a strategy like this if you handled all the work under one company.
Handle Self-Performed Work
If you operate as a general contractor and want to subcontract work, you could do so through a subsidiary you own. You could self-perform the work while protecting contractual labor rates, as they are contracted in a subcontract. You could also use this arrangement to pay union rates for self-performed work under the subsidiary and non-union rates for work under the general contractor.
Acquire Another Business
If you’re buying another construction business that’s already doing well, you could set them up as a subsidiary run by the current management team. That way, you preserve their company culture and processes. If you took the company over directly, it would risk changing what made the other construction company successful in the first place. However, you would still have the final say over important decisions while preserving the value of your acquisition.
Finding the Right Fit for Your Business
If you think a subsidiary could make sense as part of your expansion strategy, consider speaking with Aldrich’s construction accountant experts or fill out the form below to contact the author and expert, Mike Sause, CPA, CCIFP. They can further discuss the pros and cons of using a subsidiary and the process for setting one up.
Meet the Author
Mike Sause, CPA, CCIFP®
Aldrich CPAs + Advisors LLP
Mike Sause joined the firm in 2008 and provides consulting, tax planning and compliance services to businesses and their owners. He has over two decades of public accounting experience in medium sized local and regional firms and specializes in the construction industry. Mike also spent four years in banking and private accounting positions. Oregon Society... Read more Mike Sause, CPA, CCIFP®
- Certified Public Accountant
- Certified Construction Industry Financial Professional (CCIFP®)
- Strategic tax planning and compliance