Definition
A Personal Holding Company (PHC) is a specific type of corporation that meets the following criteria:
- Income Source: It derives more than 60% of its gross income, after certain adjustments, from investment sources such as dividends, interests, rents, royalties, and personal service contracts.
- Ownership: More than 50% of its stock is owned by five or fewer individuals.
Such a corporation is often colloquially referred to as an “incorporated pocketbook.” The primary punitive measure for PHCs is a penalty tax of 15% which may escalate to 35% under certain conditions. This penalty tax is applied to the corporation’s taxable income, less distributions to shareholders, income taxes, and other specific adjustments.
Examples
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Investment Corporation A:
- Derives 70% of its gross income from dividends and interest.
- Owned by three families, each holding 15% to 20% of the stock.
- Subject to PHC tax due to exceeding income from passive sources and concentrated ownership.
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Family Business B:
- Generates 65% of its income from property rentals and royalties.
- Owned entirely by five siblings.
- Classified as a PHC due to its income source and ownership concentration.
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Consulting Firm C:
- Earns 80% of its income from personal service contracts.
- Owned by a team of five consultants.
- Falls under PHC regulations because of its income and ownership criteria.
Frequently Asked Questions (FAQs)
What defines a Personal Holding Company (PHC)?
A PHC is a corporation that receives a majority of its income from passive investments and is owned primarily by a small group of individuals.
Why is there a penalty tax on PHCs?
The penalty tax on PHCs exists to deter the use of closely held corporations to avoid personal taxes on investment and personal service income.
How is the PHC penalty tax calculated?
The penalty tax is computed on the corporation’s taxable income after accounting for distributions to shareholders, income taxes, and certain other adjustments.
Who administers the PHC regulations?
The Internal Revenue Service (IRS) is responsible for identifying and administering the tax regulations for PHCs.
What are considered passive income sources for a PHC?
Dividends, interest, rents, royalties, and personal service contracts are typical examples of passive income sources for PHCs.
Can the penalty tax percentage vary?
Yes, while the standard penalty tax rate is 15%, it has provisions to escalate to 35% under specific circumstances.
Are there any exceptions to the PHC penalty tax?
Certain income types and tax credits may provide adjustments and exceptions when considering the PHC penalty tax.
How can a corporation avoid being classified as a PHC?
Corporations can avoid PHC classification by diversifying their income sources and ensuring their stock is not overly concentrated among a few individuals.
Does the PHC tax penalty apply annually?
Yes, the penalty tax applies annually based on the corporation’s taxable income for that year.
Are foreign corporations subject to PHC regulations?
PHC regulations primarily apply to domestic corporations within the United States.
Related Terms
- Corporation: A legal entity that is separate from its owners, providing them with limited liability while managing business operations.
- Passive Income: Income derived from investments, such as dividends, interest, rents, and royalties, with minimal active involvement.
- Closely Held Corporation: A corporation owned by a small number of individuals, typically family members or a closely-knit group.
Online Resources
Suggested Books for Further Studies
- Federal Income Taxation of Corporations and Stockholders by Boris I. Bittker and James S. Eustice
- Taxation of Business Entities by Alan Schenk and Oliver Oldman
- The Logic of Subchapter K: A Conceptual Guide to Taxation of Partnerships by Laura E. Cunningham and Noel B. Cunningham
Fundamentals of Personal Holding Companies: Taxation Basics Quiz
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