Parents, subsidiaries and groups
Disregarded, consolidated or separate: how a subsidiary is taxed, and a $12,000 intercompany fee booked in each entity and eliminated in the group.
A company with more than one entity is a group: a parent that owns one or more subsidiaries. Startups add them to hold a foreign team, ring-fence a risky line of business, or hold IP apart from operations. Each subsidiary is its own legal entity with its own books, bank account and filings.
Tax depends on what the subsidiary is. A wholly owned LLC that hasn't elected corporate status is a disregarded entity: its income is simply the parent's, on the parent's Form 1120. A subsidiary corporation files its own return — unless the group files a consolidated return, which an affiliated group may: a common parent and corporations it owns at least 80% of by vote and by value. A foreign subsidiary files in its own country, and its US owners may have Form 5471 to file.
Intercompany: real in each set of books, gone in the group's
Suppose Northwind formed Northwind Tools West, LLC, a wholly owned LLC, and billed it a $12,000 management fee. Each entity books its side — real in each. On consolidation the intercompany balances and the fee eliminate, because the group didn't earn anything from itself. A consolidated tax return and consolidated financial statements are separate things with separate control tests, and the accounting side is in the multi-entity doc.
Fee billed to Northwind Tools West, LLC
| Account | Debit | Credit |
|---|---|---|
| 1250Due from subsidiary | 12,000.00 | |
| 4900Management fee income | 12,000.00 | |
| Balanced | 12,000.00 | 12,000.00 |
The parent's books.
Fee owed to Northwind Traders, Inc.
| Account | Debit | Credit |
|---|---|---|
| 6900Management fee expense | 12,000.00 | |
| 2050Due to parent | 12,000.00 | |
| Balanced | 12,000.00 | 12,000.00 |
The subsidiary's books.
Eliminate intercompany fee and balance
| Account | Debit | Credit |
|---|---|---|
| 4900Management fee income | 12,000.00 | |
| 6900Management fee expense | 12,000.00 | |
| 2050Due to parent | 12,000.00 | |
| 1250Due from subsidiary | 12,000.00 | |
| Balanced | 24,000.00 | 24,000.00 |
The consolidation-only elimination: neither entity's books, only the group's.
One entity
- Good at
- One set of books and filings.
- No intercompany to reconcile.
- Watch for
Every risk sits in the same entity.
- Best for
- Staying small: one product, one country.
Parent and subsidiary
- Good at
- Liability ring-fenced in the subsidiary.
- A local entity to employ people abroad.
- Watch for
- A second set of books, filings and registered agent.
- Intercompany agreements and pricing to keep defensible.
- A consolidation every close.
- Best for
- A foreign team, a separate risky line, or IP held apart.
A subsidiary is a separate set of books; for tax it may be the parent's (disregarded), the group's (consolidated) or its own — and intercompany always eliminates in the group.
Where this lesson's rules come from
The sources behind this lesson's requirements, by kind. Background reading explains; it is never the authority for a rule. Anything marked as a convention is ours, not the rule-maker's.
- Federal statute
- 26 U.S.C. §1501 (opens in a new tab)The privilege of filing a consolidated returnFree to read
- 26 U.S.C. §1504(a)(2) (opens in a new tab)Affiliated group: the 80% vote-and-value testFree to read
- Federal regulation
- Treas. Reg. §301.7701-3(b)(1) (opens in a new tab)Default classification of a domestic eligible entity — the check-the-box rulesFree to read
- IRS guidance
- IRS, About Form 5471 (opens in a new tab)Form 5471 — US persons with interests in foreign corporationsFree to read
- Background reading — not an authority
- Wikipedia, “Subsidiary” (opens in a new tab)SubsidiaryFree to read
- Wikipedia, “Holding company” (opens in a new tab)Holding companyFree to read
The words this lesson teaches
Each links to its glossary definition, which also names the authority behind it and the components that render it.
- SubsidiaryA company that another company, the parent, owns or controls. It is a separate legal entity with its own books; a wholly owned LLC subsidiary that has not elected corporate status is disregarded for income tax but not for state law or payroll
- Consolidated returnOne federal income tax return filed by an affiliated group of corporations: a common parent and the corporations it owns at least 80% of, by vote and by value
- Disregarded entityAn eligible entity with one owner that has not elected to be a corporation, ignored for income tax so its results go on the owner's return — Schedule C for an individual owner. It is still a separate legal entity, and still the employer for employment taxes
- IntercompanyA balance or transaction between two entities in the same group — real in each entity's books, eliminated on consolidation
- EliminationA consolidation-only entry removing intercompany balances, transactions and unrealized profit, so the group does not report trading with itself
- ConsolidatedPresenting a parent and the entities it controls as one economic entity, with intercompany balances and transactions eliminated
In the founder glossary
This lesson’s ideas, explained for the founder running the company. Each has an entry in the founder glossary.
See also
- Multi-entity & FXConsolidation and currency are where finance UIs produce wrong numbers without anyone noticing. Both ask you to add up figures that look like they add up and don't: two entities that trade with each other, or euros and dollars in one column.
- EntitySelectorExplicit scope. Standalone vs. consolidated visually distinct.
- ConsolidationViewEntity columns, eliminations, NCI, group total.
- IntercompanyMatrixMust net to zero. Break types named.
- EliminationEntryConsolidation-level only, boundary visible.