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Editorial 11 MIN READ

Holding company structure, revisited: what TCJA changed and what it didn't

Twenty months after our first walk-through, the dividends-received tiers are new numbers for the same burden, §199A rides the LLC stack, and every Opportunity Zone deal is secretly a holding company

The Editors
Staff, Incorporator.org
11 min read Updated
Contents 7 sections
  1. The DRD math, redrawn against a 21% rate
  2. The C-corp-over-C-corp stack, reconsidered
  3. §199A through the LLC-over-LLC stack
  4. Opportunity Zone funds are holding companies
  5. What hasn't changed
  6. The right structure in May 2019
  7. Sources

wenty months ago we walked through the shapes a holding company actually takes and the federal rules that bind them. The shapes are the same. The federal rules underneath them are not. A flat 21% corporate rate, a rebuilt dividends-received deduction, a brand-new 20% pass-through deduction, and a capital-gains-deferral program that is structurally a holding-company contest have all arrived in the interval.

This piece is the rewrite in light of those changes, for an operator who already knows what a holding company is. Our September 2017 primer remains correct on the mechanics of formation, veil-piercing, and intercompany paper. Our April 2018 layering piece walked through the double-tax math under the new numbers. What follows adds what the last year of final regulations, court guidance, and market behavior has taught.

The DRD math, redrawn against a 21% rate

IRC § 243 sets the corporate shareholder's dividends-received deduction. Before the Tax Cuts and Jobs Act, the tiers were 70% for under-20% ownership, 80% for 20% to under 80%, and 100% for affiliated-group members at 80% or more, computed against a graduated corporate rate topping out at 35%. TCJA § 13002 (Pub. L. 115-97) cut the two lower tiers to 50% and 65% effective for tax years beginning after December 31, 2017, and § 13001 flattened the corporate rate to 21% under IRC § 11(b).

The arithmetic that fell out of those two changes is close to a wash and is the single most important number to internalize if you are designing a C-corp stack in 2019.

Under the old regime, a 70% DRD against a 35% rate produced a residual corporate tax of 35% × (1 − 0.70) = 10.5% on an under-20% intercorporate dividend. Under the new regime, a 50% DRD against a 21% rate produces 21% × (1 − 0.50) = 10.5%. Identical. At the middle tier, the old math was 35% × (1 − 0.80) = 7.0%, the new math is 21% × (1 − 0.65) = 7.35%. Slightly worse for a 20%-to-80% corporate shareholder, but roughly continuous with the pre-TCJA burden. The 100% tier produces a 0% residual under either regime because the deduction is total.

The practical effect is that the ownership thresholds did not move and the economic burden at each threshold did not meaningfully move, even though the nominal percentages look completely different. A holding-company designer who learned the old tiers and forgot to re-read the statute can still draw the right pictures. The numbers in the pictures have changed; the picture has not.

What has moved is the cost of not clearing the 80% affiliated-group threshold. Under the old 35% rate, a C-corp-over-C-corp structure that fell short of 80% cost roughly 10.5% to 7.0% on each upward dividend. Under the new 21% rate, the same structural shortfall costs the same 10.5% to 7.35%, but the opportunity cost of missing the full consolidation election is smaller in absolute dollars because every rate in the stack is lower. For structures that were borderline on the 80% test, the economic pull toward clearing it is slightly weaker than it used to be.

The C-corp-over-C-corp stack, reconsidered

Before TCJA, a C-corp parent over C-corp subs was a math problem with a reasonable answer for many mature private companies. The old 35% top rate plus qualified-dividend treatment out to shareholders produced a combined burden of roughly 48% when the cash actually came home. At 21%, the same round trip produces a combined burden of roughly 39.8%, which is close to the combined top rate on pass-through income once state taxes and the net investment income tax are layered in.

This is the structural shift the 2019 advice has caught up to. A C-corp parent that never distributes is a tax-deferred vehicle at 21%, which is lower than the top marginal ordinary rate for a working pass-through owner. For a holding structure whose purpose is to accumulate capital, redeploy it into new subsidiaries, and avoid distributing to individual shareholders for a long time, the C-corp wrapper has become materially more attractive than it was in 2017. Berkshire Hathaway's original design rationale, which rested on exactly this logic under a higher rate, has become rational for much smaller companies.

The flip side is that every C-corp holding structure carries the implicit promise that you will not, for the foreseeable future, want the cash at the shareholder level. The moment an individual owner needs distributions, the second layer of tax reappears. For family-office-style compounding structures, that promise is easy to keep. For operating companies whose owners draw on the business to live, it is not.

§199A through the LLC-over-LLC stack

The qualified business income deduction at IRC § 199A is where the pass-through side got its structural advantage. The section gives non-corporate taxpayers a deduction equal to 20% of qualified business income, subject to the W-2 wages and unadjusted basis immediately after acquisition (UBIA) limitations above the taxable income thresholds, and the specified service trade or business phaseouts. The final regulations, TD 9847, were published in the Federal Register on February 8, 2019.

The number that matters for holding-company design is that § 199A operates at the individual owner's return, not at any entity level. A wholly owned LLC parent that owns several wholly owned LLC subs is a single disregarded column under Treas. Reg. § 301.7701-3, whose income flows up to the grandparent owner. The deduction is computed against that aggregated QBI on the individual's Form 1040. Nothing at the LLC level changes the calculation.

The question that drew most of the final-regs attention was aggregation. Under Treas. Reg. § 1.199A-4, trades or businesses can be aggregated for the W-2 wages and UBIA limits if they share at least 50% common ownership (directly or by attribution), report on returns with the same taxable year, none of them is an SSTB, and they satisfy at least two of three factors: they provide products, property, or services that are the same or customarily offered together; they share facilities or significant centralized business elements; or they are operated in coordination with or reliance on one or more of the others. A holding company that owns five operating subs running the same line of business almost certainly meets the test. A holding company with five random portfolio investments almost certainly does not.

The final regulations made one important structural change from the proposed version: aggregation can now be elected at the RPE level, not just at the individual. A partnership LLC parent can aggregate its subs and pass the aggregation up to its partners, who no longer each have to independently elect the same aggregation on their own returns. This matters for any holding structure with multiple individual investors; it lets the structure speak with one voice on the aggregation question rather than producing return-level disagreements that unravel the deduction for some partners.

For a designer in 2019, the implication is that an LLC-over-LLC stack genuinely benefits from § 199A only if the aggregation test is satisfiable. If the parent is a true conglomerate, with each sub in an unrelated line, the W-2 and UBIA limits hit separately at each sub, and the taxable-income threshold phase-in bites. The pass-through structure is still preferable to a C-corp stack for most operating purposes, because a C-corp parent owning a pass-through LLC is ineligible for § 199A at all; IRC § 199A(a) limits the deduction to non-corporate taxpayers. But the magnitude of the benefit depends on whether the subs are close enough in business character to aggregate.

Opportunity Zone funds are holding companies

A Qualified Opportunity Fund under IRC § 1400Z-2 is, structurally, a holding company. The statute requires the QOF itself to be a corporation or partnership organized in the United States for the purpose of investing in qualified opportunity zone property, to hold at least 90% of its assets in QOZP, and to self-certify on Form 8996. QOZP, under § 1400Z-2(d)(2), includes qualified opportunity zone stock, qualified opportunity zone partnership interests, and qualified opportunity zone business property. Two of those three categories are equity in other entities. The QOF owns them. The QOF is a parent; the QOZBs are subsidiaries.

The two-tier structure has become the market-standard build for operating-business OZ deals and for any deal that expects to rely on the 90% asset test with real working capital. A QOF (partnership or C-corp) sits at the top. It owns a qualified opportunity zone business (QOZB) that does the actual operations. The QOZB tier gets the 31-month working-capital safe harbor for tangible property under Prop. Reg. § 1.1400Z2(d)-1(d)(5)(iv), originally in the October 2018 regs (REG-115420-18) and broadened in the April 17, 2019 second round (REG-120186-18) to cover working capital deployed into the development of a trade or business and to let the safe harbor restart under limited circumstances. That safe harbor is unavailable at the QOF level, which is why the two-tier build exists; a single-tier QOF with operating activity must keep 90% of its assets in QOZP at each of two testing dates a year, which leaves almost no room for cash.

The April 2019 regs also expanded the QOF-level flexibility in ways that matter for holding-company designers. Proceeds from the sale of QOZBP or from a distribution out of a subsidiary QOZB may be reinvested by the QOF within 12 months and, if held in cash, cash equivalents, or short-term debt instruments during the interim, count as QOZP for the 90% test. That 12-month reinvestment window is what makes a multi-deal fund administratively feasible. Without it, every distribution would force an immediate redeployment or blow the 90% test at the next semiannual measurement date.

An OZ fund designer who has not yet read the April 2019 rules should; we walked the first-round regs in our January piece. The structural rule for holding-company purposes is that a QOF is almost always a partnership (for capital-gain pass-through and for flexibility), the QOZB is almost always an LLC taxed as a partnership, and the stack resembles an LLC-over-LLC holding structure with three additional compliance constraints: the 90% asset test on the QOF, the 70% tangible property test on the QOZB under § 1400Z-2(d)(3)(A)(i) and Prop. Reg. § 1.1400Z2(d)-1(d)(3), and the substantial improvement or original use test on each piece of QOZBP.

What hasn't changed

The liability shield still depends on observance of formalities at each entity, not on federal tax design. Delaware Chancery's veil-piercing doctrine, Wallace v. Wood, 752 A.2d 1175 (Del. Ch. 1999), remains the reference point for what it takes to keep the corporate fiction. TCJA did not rewrite state entity law. The § 1504 80% vote-and-value test for consolidated returns is unchanged. The check-the-box regulations at Treas. Reg. § 301.7701-3 are unchanged. The § 482 transfer-pricing regime that polices intercompany loans, services, and licenses is unchanged. The § 269A personal-service-corporation anti-abuse rule is unchanged.

The intercompany paper file, which is still the single most important operational artifact of a real holding structure, is still what separates a stack that survives a creditor's discovery demand from one that is consolidated into a single defendant by a judge who has seen this pattern before. Five bank accounts, five sets of minutes, five EINs, written intercompany agreements that actually describe what each entity pays each other entity, and payments that actually clear when the agreements say they will. In 2019 as in 2017.

The right structure in May 2019

For an operating business with a single owner who wants pass-through treatment, an LLC parent over LLC subs, each in the state where it operates, remains the default. The § 199A deduction rides upward. If the subs share enough operational character to aggregate under § 1.199A-4, the deduction survives the W-2 and UBIA limits; if they do not, the deduction may be worth less than a pre-TCJA structural comparison would have suggested.

For a company that intends to accumulate and redeploy capital at the entity level for many years without distributing to shareholders, the C-corp holding structure at 21% has become more competitive than it was pre-TCJA. If the parent clears 80% of each sub, the consolidated return under Treas. Reg. § 1.1502-13 and following is usually better than relying on § 243's 100% DRD alone, because it nets current-year losses across members. Below 80%, the middle-tier 65% DRD and the lower-tier 50% DRD mean that every upward dividend carries a 7% to 10.5% residual corporate tax, and that number should be in the cash-flow model.

For a capital-gain investor rolling into an Opportunity Zone deal, a QOF-over-QOZB two-tier partnership stack with the working-capital safe harbor at the lower tier is now the consensus build, and the April 2019 regs have made it administrable. The 10-year exclusion under § 1400Z-2(c) is the benefit doing the heavy lifting, the seven-year 15% basis step-up is off the table for anyone who is not in by the end of this year, and the five-year 10% step-up is off the table by the end of 2021. The clock on the bonuses has been shortening since 2017 and will keep shortening.

A holding company is still a file of paper around a set of bank accounts. What changed is the federal tax regime telling the paper what to say. The designs that were structurally right in 2017 are still structurally right; the numbers in them are different, and the set of deals they can reach now includes an entire federal capital-gains program that did not exist when we first wrote this piece.

Sources

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