CONSTRUCTION Accounting ARTICLE -
Contractor Divides Company into Multiple Entities
Target Audience: Construction Industry Professionals, General Contractors, Construction Accountants
A general contractor who typically worked on the construction or rehab of commercial office buildings was interested in taking on some state and federal projects. But he knew such jobs could be tricky and worried about his company’s lack of experience.
For some advice, he sat down with his financial advisor. Multiple business entities, the advisor suggested, could provide one way to safeguard his established company’s reputation while offering potential legal and tax benefits as well.
Breaking it up
The advisor suggested that the contractor form a holding company that would own the major assets of his business, including construction equipment.
The holding company would own two operating entities: one for the contractor’s main operations and another for his new line of public projects. Both subsidiary companies would maintain minimum balances of working capital and equity, and the contractor would have full ownership of all three businesses.
Creating separate entities for the contractor’s assets and operations meant that anyone who filed a claim related to the contractor’s work couldn’t access the bulk of his worth. The arrangement would also shield the contractor’s main (commercial office building) operations from risks on any government projects.
In addition, the new structure could offer tax benefits. For example, if the contractor qualified for the manufacturers’ deduction (also known as the domestic production activities deduction or the Section 199 deduction), he might be able to maximize the tax break by forming a separate entity to perform projects and claim the deduction.
Minding the details
Although the proposed entities would be closely related, the advisor emphasized that the contractor would need to operate each one independently.
If one business borrowed money from another, the loan would have to be documented. And when the company that held the assets leased construction equipment to the operating businesses, the rental would have to be at a fair market price. If the businesses weren’t run separately, the advisor cautioned, it could create a legal issue that might result in the businesses having to combine.
In addition, Generally Accepted Accounting Principles (GAAP) require that, under certain circumstances, business owners consolidate so-called “variable interest entities” on their financial statements. The rules here are complex, so the financial advisor stressed that they would need to discuss this matter in greater detail at a later date.
Taking the plunge
Although splitting into multiple entities required considerable time and paperwork, the contractor took the plunge (with the help of his financial advisor and an attorney). Once the new entities were in place, he was able to start bidding on the government projects with a little less worry on his mind.
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