PORTFOLIO

Personal Holding Companies (Portfolio 797)

Tax Management Portfolio, Personal Holding Companies, No. 797-4th, considers all aspects of the personal holding company tax. In general terms, the tax is imposed on corporations which are more than 50% owned by five or fewer individuals (the ownership test) and which derive 60% or more of their income from personal holding company sources (the income test).

Price: $400 Print

GET MORE WITH THE FULL PORTFOLIO LIBRARY

This Portfolio is part of the U.S. Income Portfolios Library, a comprehensive resource including 200+ federal tax Portfolios, practice tools, primary sources and timely news.

FREE TRIAL

DESCRIPTION

Tax Management Portfolio, Personal Holding Companies, No. 797-4th, considers all aspects of the personal holding company tax. In general terms, the tax is imposed on corporations which are more than 50% owned by five or fewer individuals (the ownership test) and which derive 60% or more of their income from personal holding company sources (the income test).


The ownership test is applied using attribution rules to determine the number of owners and the size of their interests. In applying the income test, the corporation's gross income is computed and then is adjusted to arrive at “ordinary gross income.” A further adjustment to that figure leads to the corporation's “adjusted ordinary gross income.” If “personal holding company income,” basically taxable income with certain upward and downward adjustments, is 60% or more of adjusted ordinary gross income, the income test is met. If the corporation satisfies the ownership test and the income test, it is classified as a personal holding company and it is taxed on its “undistributed personal holding company income.” Certain distributions (and deemed distributions) can reduce undistributed personal holding company income and, as a result, the tax.


The personal holding company tax can arise unexpectedly and may lead to serious consequences. However, an understanding of the personal holding company provisions and an awareness of their potential application will help to avoid their pitfalls. This Portfolio: (1) analyzes the rules for determining whether a corporation is a personal holding company; (2) explains how the personal holding company tax is computed; and (3) demonstrates planning techniques which may prevent imposition of the tax.


Buy Personal Holding Companies (Portfolio 797) now


AUTHORS

RICHARD C. FUNG
Richard C. Fung, Amherst College (B.A., cum laude, 1991); Columbia University School of Law (J.D. 1994); Associate, Skadden, Arps, Slate, Meagher & Flom LLP (1994-2001); Principal, Ernst & Young LLP, Transaction Advisory Services; adjunct professor, Tax LLM program, Loyola Law School.

TABLE OF CONTENTS

Detailed Analysis

I. Introduction

II. General Pattern of Personal Holding Company Provisions

A. Definition of “Personal Holding Company”

1. The Income Test

2. The Stock Ownership Test

B. Treatment of a Personal Holding Company in General

III. Corporations Excepted from Personal Holding Company Status

Introductory Material

A. Tax-Exempt Corporations

B. Banks

C. Life Insurance Companies

D. Surety Companies

E. Foreign Corporations

F. Lending or Finance Companies

1. 60% Test

2. 20% Test

3. Business-Expense Test

4. Limitation on Loans to Shareholders

5. Relationship Between 542(c)(6) and 542(c)(2)

G. Small Business Investment Companies

H. Corporations in Title 11 or Similar Cases

I. S Corporations

J. Pre-2005 Exceptions for Foreign Personal Holding Companies and Passive Foreign Investment Companies

IV. Definition of a Personal Holding Company: The Income Test

A. In General

B. Gross Income

1. In General

2. Manufacturing, Merchandising, and Mining Businesses

3. Farming

4. Service Businesses

a. In General

b. Absence of a Profit Motive

c. Reimbursed Expenses

5. Installment Sales

6. Partnerships

7. Insurance Companies Other Than Life Insurance Companies

8. Foreign Corporations

C. Definition of “Ordinary Gross Income”

1. In General

2. Section 1231 Gains

3. Sections 1245 and 1250 Gains

D. Definition of “Adjusted Ordinary Gross Income”

1. Adjustments to Gross Income from Rents

a. Income from Rents

b. Adjustments in General

c. Exception for Depreciation on Certain Tangible Personal Property

d. Deductions Allocable to Rents

e. Interest on Loans Not Used to Purchase Property

2. Adjustments to Mineral, Oil, and Gas Income

a. In General

b. Deductions Allocable to Royalties and Working Interests

3. Interest Income Exclusions

E. Personal Holding Company Income (PHCI)

1. Dividends, Etc.

a. Dividends

b. Interest

(1) In General

(2) Interest Excluded from the Interest Category

(3) Items That May Be Treated as Interest Although Not Characterized as Interest by Parties

(4) Imputed Interest

c. Royalties (Other Than Mineral, Oil, Gas, or Copyright Royalties)

(1) General Definition

(2) Royalties Compared with Joint Venture Income

(3) Royalties Compared with Capital Gains

(4) Royalties on Computer Software

d. Annuities

2. Rents

a. Items Constituting Rent

(1) Rents Contrasted with Royalties

(2) Compensation for Use of Tangible Personal Property Manufactured by Taxpayer

(3) Interest on Sale of Real Property

(4) Delay Rentals

(5) Joint Operating Agreements

(6) Expenses of Lessor and Improvements

b. Test for Treating Rent as Personal Holding Company Income (PHCI)

(1) Fifty Percent Test

(2) Ten Percent Test

(a) In General

(b) Distributions of Other Personal Holding Company Income

3. Mineral, Oil, and Gas Royalties

a. Items Constituting Mineral, Oil, and Gas Royalties

b. Tests for Treating Mineral, Oil, and Gas Royalties as Personal Holding Company Income

(1) Fifty Percent Test

(2) Ten Percent Test

(3) Fifteen Percent Test

4. Copyright Royalties

a. Fifty Percent Test

b. Ten Percent Test

c. Twenty-Five Percent Test

5. Produced Film Rents

6. Rents from 25% Shareholders

a. In General

b. What Constitutes Use by an Individual

c. Compensation for Use of Property

d. Ten Percent Test

7. Personal Service Contracts

8. Estates and Trusts

F. The Sixty Percent Test

V. Definition of a Personal Holding Company: The Stock Ownership Test

A. In General

B. Stock Ownership as a Factor of Personal Holding Company Income

1. Personal Services Contracts

2. Use of Corporate Property

3. Royalties as Personal Holding Company Income

C. Valuation of Stock

D. Amount of Stock Outstanding

E. Period of Ownership

F. Direct or Indirect Ownership

VI. Attribution of Ownership Under 544

A. Situations in Which Attribution Rules Apply

B. Stock Held by a Corporation, Partnership, Estate or Trust

1. In General

2. Constructive Ownership of Trust or Estate Assets

C. Constructive Ownership by Reason of Family and Partnership Ownership

1. Family Attribution

2. Attribution Between Partners

D. Convertible Securities

1. General

2. Securities Convertible at Different Times

E. Constructive Ownership by Reason of Options

1. In General

2. Period of Constructive Ownership

F. Attribution Rules Apply Only Against Taxpayer

G. Reattribution

1. Situations in Which There Will Be Reattribution

2. Situations in Which There Will Not Be Reattribution

a. Family or Partner Attribution

b. Convertible Securities

H. Option Rule in Lieu of Family and Partner Rule Where Both Are Applicable

VII. Corporations Filing Consolidated Returns

A. In General

B. Exceptions

1. Ineligible Affiliated Groups

a. Test for Ineligible Groups

b. Dividends Received by a Common Parent

2. Excluded Corporations

C. Consolidated Income for Personal Holding Company Purposes

1. In General

2. Certain Dividend Income Received from a Nonincludible Life Insurance Company

3. Treatment of Dividends Received by Members of an Affiliated Group

D. Effect of Determining Personal Holding Company Liability on a Consolidated Basis

E. Importance of Planning

VIII. Return Requirement for Personal Holding Companies

IX. Computation of the Personal Holding Company Tax

X. Computing Undistributed Personal Holding Company Income

A. Taxable Income

B. Adjustments Under 545(b)

1. Taxes

2. Charitable Contributions

3. Dividends Received Deduction

4. Net Operating Loss

5. Net Capital Gain

6. Certain Expenses and Depreciation

C. Adjustments Under 545(c)

D. Adjustments Under Pre-1990 545(c)

XI. Dividends Paid Deduction

A. In General

B. Definition of Dividend

1. In General

2. Formal Declaration

3. Dividends in Kind

4. Distributions in Liquidation

a. General Comments

b. Distributions to Corporate Distributees

c. Distributions to Noncorporate Distributees

d. Interrelation with 543(a)(2)

e. Liquidating Distribution Constituting Step in Reorganization

C. Preferential (Disproportionate) Dividends

D. Tax-Free Distributions

E. Distributions by Member of an Affiliated Group

F. Dividends Paid After Close of Taxable Year

G. Dividend Carryover

H. Consent Dividends

1. General Purpose

2. Consent Procedure

3. Effect of Consent

4. Definition of Consent Stock

5. Limitation on Consent Dividends

a. Preferential Dividends

b. Section 316 Limitation

6. Nonresident Aliens and Foreign Corporations

I. Deficiency Dividends

1. In General

2. Need for Determination

3. Payment of Deficiency Dividend

4. Claim for Deduction

5. Effect on Dividends Paid Deduction

6. Interest, Additional Amounts, or Penalties

7. Credit or Refund

8. Limitation on Assessment and Collection

9. Stay of Collection

10. Liquidated Corporation

11. Successor Corporation


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Revenue Act of 1964, P.L. 88–272, 88th Cong., 2d Sess. (1964), Excerpts Section 225-Personal Holding Companies

Worksheet 2 Foreign Investors Tax Act of 1966, P.L. 89–809, 89th Cong., 2d Sess. (1966), Excerpts Act Section 104(b), Amending Code 882 Act Section 104(h), Amending Code 542, 543, and 545 Senate Report on Foreign Investor Tax Act of 1966

Worksheet 3 Foreign Investors Tax Act of 1966, P.L. 89–809, 89th Cong., 2d Sess. (1966), Excerpts Act Section 206, Amending Code 543 Senate and Conference Committee Reports on Section 206

Worksheet 4 Tax Reform Act of 1976 P.L. 94–455, 94th Cong., 2d Sess. (1976) Excerpts Act Sec. 2106, Amending Code 543 Senate Report on the Tax Reform Act of 1976 General Explanation of the Tax Reform Act of 1976

Worksheet 5 Tax Equity and Fiscal Responsibility Act of 1982 P.L. 97–248, 97th Cong., 2d Sess. (1982) Excerpts Act Section 293, Amending Code 542 House Report on Tax Equity and Fiscal Responsibility Act of 1982

Worksheet 6 EXAMPLE Computation of Undistributed Personal Holding Company Income (UPHCI)

Worksheet 7 Statement by Personal Holding Company Claiming Rental Expenses in Excess of Rental Income (Regs. 1.545–2(h)(2))

Worksheet 8 Corporate Designation of Distribution in Complete Liquidation as Dividend (Regs. 1.316–1(b)(5))

Bibliography

OFFICIAL

Statutes:

Primary:

Secondary:

Treasury Rulings:

Cases:

UNOFFICIAL

Periodicals:

1986

1987

1991

1992

1993

2000