Does an LLC Subsidiary Need a Separate Checking Account?
An LLC -- limited liability company -- subsidiary is a separate legal entity that has all the rights of a company, but is wholly or partially owned by a larger company, known as the parent. The purpose of separating companies into stand-alone legal entities is to limit the potential adverse financial loss associated with the failure of the subsidiary. To protect the assets of the "parent" company, legal requirements need to be met to ensure potential litigants do not "pierce the corporate veil" of the LLC.
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LLC Subsidiaries and the Law
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Thousands of state and federal laws govern businesses. An example of how the law affects both parent and subsidiaries is reflected in the case of American Electric Power Co. v. Affiliated Insurance Company. The case involved a parent company that had corporate insurance on its companies formed as LLCs. Under the terms of the insurance, only "corporations" were insured by the policy, which invalidated the insurance coverage the parent company bought to cover its LLC subsidiaries.
Piercing the Corporate Veil
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A court of law may pierce the veil of a company under certain circumstances, including the parent company's comingling of assets, failure to file adequate legal and financial documentation and manipulating financial statements regarding assets and liabilities. Failing any of these tests, as well as a number of others, can lead to a court ruling that the companies are not separate and distinct entities. Therefore, each is liable for the others' liabilities. Owners can also be held personally liable.
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Protecting the Parent Company
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To protect the parent company from actions of the subsidiary requires both companies to have separate articles of incorporation and/or organization documents, distinct management, arm's length relationships, separate checking accounts and financial statements to protect both companies from the actions of the other. For instance, a parent manufacturing company that owns a subsidiary trucking company not legally structured as a distinct legal entity is legally liable if the trucking company is involved in an accident or found to be defrauding investors.
Benefits of the Parent/Subsidiary Structure
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In business, a primary considerations is how to protect the owner from personal liability if the business fails. A second consideration focuses on how to limit liability of a company with various divisions and revenue streams. A third consideration, in structuring a subsidiary, is predicated on achieving tax benefits that result in higher profit margins. For instance, a manufacturing company that owns natural resources can benefit by structuring the parent company as a corporation and placing all company assets into a "holding" company, structured as an LLC subsidiary. In the case of a timber and lumber manufacturing company that owns timberland, placing the timberland into a LLC subsidiary, resulting in revenue being taxed as a capital gain. As an additional benefit, any lawsuit against the parent company shields company assets via the subsidiary.
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