Management Company Structures: Charging Fees Between Related Businesses

Owners with several related businesses sometimes set up a separate "management company." The idea is intuitive: one entity employs the administrative team, holds contracts with shared vendors, and charges the operating businesses a fee for the services. Done well, it simplifies operations. Done for tax mystique, it invites trouble.

What a management company actually is

A management company is an entity that provides services (management, administration, marketing, bookkeeping, staffing, or executive leadership) to other entities. The recipients pay a fee, and the management company records revenue and pays the expenses of providing the services, primarily payroll.

It is not a tax loophole. It is a way to organize who employs whom and who bears which costs. Whether the structure helps depends on your specific facts, and many small businesses do not need one.

Legitimate reasons to use one

Multiple operating entities with shared staff. A single employer for the shared team can be easier than splitting payroll among several companies.
Consolidated overhead. Centralizing software, insurance, or professional services in one entity, with a fee to allocate costs.
Separating employee liability from asset-holding entities. For example, real estate entities do not hire employees. The management entity does.
Preparing for sale of one business. Keeping shared staff outside the entity being sold, while providing transition services under an agreement.
Multiple ownership groups. Different owners in different businesses might use a management company to provide services at agreed prices.
Licensing or regulatory reasons, such as professional practices where non-professionals provide administrative services through a separate entity, subject to state rules on fee splitting and corporate practice of professions.

What the fee should represent

The fee should compensate real services at prices that resemble what unrelated parties would pay. Typical approaches include:

Cost plus a markup. The management company charges its costs plus a modest margin.
A percentage of revenue. This is common in franchises and some industries, but for related parties it should still bear a reasonable relationship to the services.
A fixed monthly fee based on a documented scope.
Hourly or per-project pricing for defined services.

Whatever the method, write it down. The agreement should describe the services, the fee, payment terms, term, termination, confidentiality, and who is responsible for what liability. See intercompany charges and agreements.

Tax considerations

Deductibility. The operating business generally deducts management fees paid for real services as ordinary and necessary business expenses. Related-party payments are examined for reasonableness and substance. If the service is not performed, or the fee bears no relationship to value, the deduction can be denied.

Income to the management company. The fee is income to the management company, taxed according to its classification. If it is a disregarded entity owned by the same individual, the result is often the same as if the fee had not been charged, because all entities report on the same return. If the entities are separate taxpayers, the fee shifts income from one to the other.

Self-employment tax and payroll tax. Shifting income among entities owned by the same individual does not by itself avoid self-employment tax on active income. For S-corps, the management company's wages and the operating company's reasonable compensation must reflect the owner's actual services. A structure that pays the owner little salary and large fees may draw scrutiny. See S-corp reasonable compensation.

Qualified business income. Payments between related pass-through entities can affect the QBI deduction, and the rules have anti-abuse provisions concerning commonly controlled businesses. Ask an adviser.

State taxes. Some states tax services differently, or apply combined reporting to related businesses. Sales tax may apply to certain management or administrative services in some states.

Payroll and employment. The management company as employer must handle payroll taxes and benefits, and consider joint employer risks. Employees who work for several entities should have clear written arrangements.

Liability considerations

A management company that employs the staff carries employment risks (wage claims, workplace injuries). Operating companies that use the staff may still be treated as joint employers. The management agreement should include indemnities, insurance requirements, and clarify supervision. An operating entity that uses staff with no agreement may have exposure and no clear right to reimbursement.

Also consider what the management company owns. If it owns equipment, software licenses, or the workforce, an operating company relies on it. If the management company gets sued, its assets are at risk, so it should not also hold major valuable assets it does not need.

Accounting

Record each payment as revenue in the management company and as an expense in the operating company. Reconcile intercompany balances monthly. Avoid paying invoices from a personal card or from another entity without recording. See bookkeeping systems for small business.

When a management company is unnecessary

You run one business with one team.
Your entities are all disregarded and you hire directly into the main entity.
The added cost of a separate payroll account, insurance, and returns exceeds the benefit.
The only motivation is a tax idea that you cannot explain in terms of business operations.

Red flags

Fees that change from month to month to move income to whichever entity has the lower tax result.
No written agreement.
The management company has no employees or real functions.
The owner's compensation runs through a management fee rather than through payroll where a shareholder-employee relationship exists.
Fees that are not actually paid, or are "accrued" for years.
Inconsistent treatment of the same service in different periods.

Building it properly

Identify the services and who currently provides them.
Decide which entity will employ people.
Choose a pricing method and document it.
Write a management services agreement.
Obtain the necessary EINs, registrations, and insurance.
Set up bookkeeping to track intercompany billing.
Review tax and state rules with a professional.
Revisit the fee annually.

For a review of whether a management company would help or hinder your particular setup, AE Tax Advisors can help, and a discovery call is a good place to begin. Related structural reading: holding company basics and parent and subsidiary LLCs.