Many companies set up separate corporations to protect themselves from liability claims. You may decide to do this when you open a new store, introduce a new product line, or set up a new manufacturing division. When you or family members together own 80% or more of both companies, the IRS's multiple-corporation rules treat the combined income as if there were only one corporation. That can make quite a difference in your tax bill, since often the companies would be subject to a lower rate if they were eligible to be taxed separately.
What you might want to consider in this case is giving up ownership of 20% of the new corporation to a nonfamily member who owns no stock in the old corporation -- to the person who is going to manage it, for example. Obviously, taxes would be only one of many things you'd consider before making such a move, but let's say it would make sense for your business. To illustrate the tax savings, let's take a $4-million company, Old Corp., with earnings in 1988 of $285,000, and a second corporation, New Corp., with earnings of $50,000 in 1988. Here's how the companies would be taxed under both arrangements: