Sidestep tax on personal holding companies — Business Management Daily: Free Reports on Human Resources, Employment Law, Office Management, Office Communication, Office Technology and Small Business Tax Business Management Daily

Sidestep tax on personal holding companies

Get PDF file

by on
in Small Business Tax,Small Business Tax Deduction Strategies

A tax that is often thought to be a remnant of days long gone by can still come back to haunt business owners.

Strategy: Don’t trigger the personal holding company tax. This additional tax can be assessed against a closely held company if it receives excess investment income.

However, with some careful tax planning, you may be able to avoid any dire tax consequences.  

Here’s the whole story: A personal holding company (PHC) is a C corporation in which more than 50% of the value of its outstanding stock is owned—either directly or indirectly—by no more than five individuals and at least 60% of its adjusted ordinary gross income comes from passive sources. The PHC tax is imposed on the undistributed income of these C corporations. In other words, the tax targets closely held corporations deriving substantial investment income such as royalties, interest, dividends and rents.

Currently, a PHC must pay a corporate tax equal to 20% of the undistributed PHC income. From 2003 to 2012, the tax rate was 15%, but the American Taxpayer Relief Act of 2012 (ATRA) raised it by 5%.

The PHC tax can strike when least expected.

New ruling: XYZ Corp., a closely held company, owned land surrounding a commercial building of a related corporation. XYZ agreed to place building restrictions on the land to provide a “buffer zone.” But the IRS ruled that payments received by XYZ for this privilege should be treated as rents, pushing it over the 60% passive income threshold. (IRS Chief Counsel Memorandum, No. 20152012F, 5/22/15)

To avoid the PHC tax, you might increase the number of shareholders. But be aware that stock gifted to other family members will be considered to be owned indirectly by you.

  • Alternatively, you may be able to increase adjusted ordinary income or decrease PHC income. A few ideas are to:
  • Accelerate billing for business services or sales near year-end
  • Decrease cost of goods sold by deferral of purchases or other expenses at year-end
  • Invest in business activities that result in additional gross receipts that are not PHC income
  • Cash in securities and reinvest the funds in stocks that have growth potential but do not regularly pay dividends
  • Pay out dividends to shareholders
  • Limit your passive investments

Tip: Certain businesses, such as banks and life insurance companies, are specifically exempted from the PHC tax.

Leave a Comment

 

Previous post:

Next post: