A C corporation holding investments can owe a 20% personal holding company tax in addition to its regular corporate income tax. I do not come across…

A C corporation holding investments can owe a 20% personal holding company tax in addition to its regular corporate income tax. I do not come across personal holding companies often, but they are challenging to deal with.

What is a personal holding company? There are two tests, subject to statutory exclusions.

For the income test, at least 60% of its adjusted ordinary gross income for the taxable year must be "personal holding company income".

For the ownership test, more than 50% in value of the outstanding stock must be owned, directly or indirectly, by or for five or fewer individuals at any time during the last half of the taxable year.

Ownership is determined under the attribution rules. Stock held through corporations, partnerships, estates and trusts can be attributed to their owners or beneficiaries. Family and partner attribution can also apply.

To apply the 60% income test, we compare two amounts defined by the tax rules.

Personal holding company income includes dividends, interest, annuities and certain royalties. Rents, shareholder use of corporate property and certain personal-service contracts have their own rules.

“Adjusted ordinary gross income” is the amount against which that income is measured. Ordinary gross income excludes gains from sales of capital assets and §1231 property. Further adjustments apply, including specified expenses attributable to rental income.

Divide personal holding company income by adjusted ordinary gross income to see whether it reaches 60%. Do not simply divide investment receipts by total book revenue. And do not assume a corporation avoids PHC status because it also operates a business.

If the two tests are satisfied and no exclusion applies, the corporation is a personal holding company.

Amount Subject to Tax

A separate calculation determines the amount subject to the additional tax - it begins with taxable income, makes the adjustments required by §545, and subtracts the dividends-paid deduction. Adjustments include federal income taxes and special treatment of capital gains, charitable contributions, corporate deductions and net operating losses.

The result is undistributed personal holding company income. The 20% tax applies to that computed undistributed amount. It does not apply automatically to all corporate assets, all accumulated cash or all book earnings.

This is a separate regime from accumulated earnings tax. A corporation that is a personal holding company is excluded from the accumulated earnings tax. Documenting reasonable business needs (the familiar AET inquiry) does not by itself remove PHC status or its additional tax.

A dividend can reduce the corporation’s PHC exposure and produce tax for the shareholder. The decision depends on the corporate deduction, the timing of the distribution and the tax paid by the recipient.

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