Cream of the Crop 1/Cream of the Crop 1.iso/BUSINESS/SBA62.ARJ/FSBA.EXE/F310.SBE

Text File | 1992-04-30 | 14KB | 380 lines

@Q01

             ┌──────────────────────────────────────────┐
             │ IS MY COMPANY POTENTIALLY SUBJECT TO THE │
             │   PERSONAL HOLDING COMPANY PENALTY TAX?  │
             └──────────────────────────────────────────┘

Many years ago, the tax laws were amended to keep wealthy individuals
from "incorporating their pocketbooks," e.g., putting their stocks,
bonds, and other investments into corporations, in order to take advan-
tage of the much lower corporate tax rates that obtained at the time.
Now, nearly six decades later, corporate tax rates are generally higher
than the rates individuals pay--but old tax laws never seem to die,
once they are on the books.

As a result, the tax law still imposes a "personal holding company" (or
"PHC") penalty tax at a rate of 28% on the "undistributed PHC income"
of companies that are determined to be personal holding companies.

  QUESTION:   Is your business incorporated (or will it be) ?

@YN
01\Q03
02\Q02

@Q02

CONCLUSION:  Then you do not have to be concerned about the personal
holding company tax problem.  It only applies to corporations.

@STOP

@Q03


  QUESTION:  Is your corporation an S corporation?

@YN
01\Q04
02\Q05

@Q04

CONCLUSION:  Then your corporation is not subject to the personal hold-
ing company provisions, which apply only to "C corporations," and not
to "S corporations."

@STOP

@Q05

OTHER EXEMPT CORPORATIONS.  Certain other special kinds of corporations
are exempted from the personal holding company tax.   These include the
following kinds of corporations:

       . banks;

       . life insurance companies and surety companies;

       . certain lending or finance companies that meet special tests;

       . foreign personal holding companies (these come with their own
         distinct set of tax problems);

       . tax-exempt organizations, and various other special kinds of
         corporations.

  QUESTION:  Does your corporation fall within any of the above
             exemptions (or any others that you know apply)?

@YN
01\Q06
02\Q07

@Q06

CONCLUSION:  Then, as such an entity, your corporation does not need
to be concerned with the personal holding company tax, due to its
special status.

@STOP

@Q07

STOCK OWNERSHIP REQUIREMENT.  Your corporation will not be treated as a
personal holding company unless its stock is controlled by a very small
number of people, directly or indirectly.  The rules for determining
when stock in a company is "indirectly" owned by someone are extremely
complex and difficult to work with, so you may need to consult a tax
professional if you aren't sure whether the corporation is more than
50% owned, directly and/or indirectly, by five people (or fewer).

Otherwise, just assume that, for example, any stock in the corporation
in question that you own, or that is owned by your family, or by corp-
orations, trusts, or partnerships in which you have an interest, will
probably be "attributed" to you, and the same goes for any other person
who may have indirect ownership of some of the stock.

  QUESTION:  Do 5 or fewer individuals own, directly or indirectly,
             more than 50% of the total outstanding stock of the
             company in question?

@YN
01\Q09
02\Q08

@Q08

CONCLUSION:  Then the corporation is not a "personal holding company,"
since its stock is too widely held.  Thus, so long as no 5 or fewer
individuals own over 50% of the stock (including indirect ownership
that is "attributed" to them), the company will not be subject to
the personal holding company tax.

CAUTION:  As noted above, the PHC stock ownership and stock attribution
rules are VERY complex and tricky.  Thus, before you blithely assume
that you escape the PHC rules on account of the stock ownership test,
you may wish to consult your tax adviser.

Of course, just because 5 or fewer people own, or are considered to
own, over 50% of a corporation does not mean that the corporation is a
PHC, if it does not have significant "personal holding company income."
Thus, you may want to go through this Question & Answer session again,
and next time answer "YES" to the stock ownership question, just to see
if you would escape the PHC definition based on the type of income your
corporation generates.

@STOP

@Q09

PERSONAL HOLDING COMPANY INCOME:  If your C corporation derives 60% or
more of its "adjusted ordinary gross income" ("AOGI") from certain
types of income, such as rents, annuities, interest or dividends, it
may be subject to the federal "personal holding company tax."  Other
kinds of PHC income to be considered in this 60% test are:

   . most kinds of royalties;

   . "produced film rents" (with certain exceptions);

   . amounts received for use of corporate property (tangible prop-
     erty) by a 25% or greater shareholder of the corporation; and

   . income received from certain personal service contracts (such
     as a professional athlete or entertainer, for example), where
     the designated performer owns 25% or more of the stock.

  QUESTION: Is personal holding company income 60% or more of "AOGI"?
@YN
01\Q11
02\Q10

@Q10

CONCLUSION:  Then it would appear that your corporation does not cur-
rently have a personal holding company tax requirement, since its items
of "personal holding company income," as listed above, amount to less
than 60% of "adjusted ordinary gross income."  Looked at another way,
your company is free of personal holding company tax problems if over
40% of its ordinary gross income each tax year comes from some kind of
active business income, such as sales of merchandise or income from
rendering personal services, for example.

@STOP

@Q11

TENTATIVE CONCLUSION:  Then your company may be in danger of having to
pay a 28% personal holding company tax on any after-tax PHC income that
it fails to distribute as dividends to shareholders.  However, not all
is necessarily lost, if over 50% of its ordinary gross income ("OGI")
or adjusted ordinary gross income ("AOGI"), depending on the category,
comes from any ONE of the following specific categories:

   . rents--if over 50% of AOGI is from "adjusted income from rents";

   . mineral/oil/gas royalties--if as adjusted, is over 50% of AOGI;

   . copyright royalties (other than from works by shareholders)--if
     such qualifying royalties constitute over 50% of OGI;

   . active business computer software royalties--if over 50% of OGI;

   . "produced film rents"--if over 50% of the corporation's OGI.

  QUESTION:  Does your firm qualify under one of the above 50% tests?
@YN
01\Q13
02\Q12

@Q12

FURTHER CONCLUSION:  Then it seems, from the answers you have given,
that your corporation may have a personal holding company tax problem.

If so, this means that you have two practical choices, if you cannot
find some way to escape PHC status:

  (1) Pay the 28% penalty tax on any personal holding company income
      that is not distributed to shareholders.  Note that in computing
      the amount of undistributed personal holding company income, for
      purposes of the tax, you start with TAXABLE INCOME of the corpor-
      ation, reduced by federal income taxes accrued for the year, and
      make several other adjustments, two of the major ones being:

        . Not being allowed a net operating loss deduction (except
          for a loss incurred in the preceding year); and

        . Not being allowed the 70% or 80% dividends-received
          deduction for dividend income from stock investments.

  (2) Pay out all of the personal holding company income (as adjusted,
      per the preceding paragraph) as dividends to shareholders.  This
      will result in double taxation of course, since you would be
      paying out all of the after-tax income of the corporation, essen-
      tially, and the shareholders would pay individual income tax on
      the dividends they received--Not a very good result either.

PLANNING SUGGESTIONS:

  . Try to zero out net income of the corporation by paying the largest
    salaries you feel that you can justify, to shareholder-employees.
    In many PHC situations, however, where most of the income is from
    passive investments, you may be likely to run into "reasonable
    compensation" problems with this approach, where the IRS takes the
    position that salaries are excessive, and therefore are really
    dividends in disguise.  In that case, the IRS will disallow the
    excess or "unreasonable" compensation as a deduction to the
    corporation.

  . Have the corporation elect S corporation status, if it is eligible
    to make such election.  S corporations are not subject to the per-
    sonal holding company tax.  However, even if S corporation status
    can be elected, a company that had PHC problems is very likely to
    have lots of "passive income" that may be subject to the special S
    corporation tax, at a 34% rate (where "passive investment income"
    exceeds 25% of gross receipts).  Also, there can be other drawbacks
    in electing S corporation status, which you would need to consider.

  . A more aggressive approach would be to have the corporation go into
    some kind of active business, where it generates gross revenues
    that exceed 40% of ordinary gross income.  Such a new business does
    not even need to show a net profit:  If it generates GROSS revenues
    that are more than 40% of "adjusted ordinary gross income," your
    personal holding company tax problem is solved.  (This could back-
    fire on you of course, if the new business LOSES a lot of money--
    Saving on taxes isn't the only thing to consider!)

@STOP

@Q13

FURTHER CONCLUSION:  Then you MAY be exempt from the personal holding
company tax, if your firm also meets a number of other complex defini-
tional requirements (each different) that apply to each of the 5 cate-
gories of special types of PHC income.  For example, for some of the
categories, the business must have certain types of business expenses
that exceed 15% (for mineral, oil & gas royalties) or 25% (for active
business computer software royalties) of OGI or AOGI.

Also, for several of the categories, other types of PHC income must not
exceed 10% of the ordinary gross income (OGI).  Numerous other complex
requirements apply, so it is strongly recommended that you DO NOT,
based on this information, conclude that you don't have a PHC tax prob-
lem because you think you qualify under one of the 50% exceptions.  You
will definitely need to consult a competent tax professional for expert
help in determining if your corporation meets one of the 50% tests and
all the related requirements for avoiding treatment of your major cate-
gory of income as personal holding company income.

The only conclusion you should draw on your own at this point is that
you MAY have a shot at avoiding PHC status; but heed this advice:

  .  SEE YOUR TAX ADVISER ABOUT THIS.

  .  THIS IS NOT THE TIME OR PLACE FOR "DO-IT-YOURSELF" BRAIN SURGERY.

  .  YOU ARE IN VERY DEEP WATER HERE!

@STOP

@HELP

@H\01

Answer "YES"  ("Y") to  this  question
even if you are not incorporated,  but
are at least seriously considering the
possibility  of incorporating.   (Then
answer the questions that follow AS IF
your business were incorporated.)

@H\03

An  S corporation is a  regular corpora-
tion that has filed an election with the
IRS (on Form 2553) to be taxed under the
provisions of Subchapter S of the Inter-
nal Revenue Code. That is, it has chosen
to have its income or losses "pass thru"
and be taxable to  (or deducted by)  its
shareholders,  rather than paying income
taxes at the corporate level.

@H\05

Other corporations exempted from the PHC
provisions include:

  . Small Business Investment Companies,
    if no shareholders own a 5% or more
    interest in any small business to
    which the SBIC provides funds.

  . Certain foreign corporations, if all
    their stock is owned, during the
    last half of the taxable year, by
    non-resident aliens and/or foreign
    entities owned by non-resident
    aliens.

@H\07

Note that, even if you only hold an op-
tion to  acquire stock of  the company,
you are  considered  as already  owning
the  stock subject  to the option,  for
purposes of  the PHC attribution rules.
These rules on indirect stock ownership
are very wide-reaching, and hard to get
around.

@H\09
"Adjusted Ordinary Gross Income"  is the
ordinary GROSS income (excluding capital
gains) of a corporation,  before any de-
ductions, except for certain adjustments
applicable to  rental income and mineral
and oil and gas royalty income (such  as
depreciation or depletion, property tax,
interest and rents paid), and other mis-
cellaneous  adjustments that  apply only
to  certain  kinds of  special taxpayers
and types of income.   Rather technical!

(You may want to just look at  gross in-
come, less capital gains, to get a rough
idea of whether you have a PHC problem.)
@H\10

PLANNING TIP:  If your company has a PHC
tax  problem,  or is  close to the line,
under the 60% test, one way to solve the
PHC problem would be for the corporation
to enter some kind of active business as
a sideline. Such a new business does not
even need  to show a  net profit:  If it
generates  GROSS revenues  that are more
than 40% of the  corporation's  adjusted
ordinary gross income, the personal hol-
ding company tax problem is solved.

@H\11

NOTE:  Each of these five categories has
its own set of special,  different,  and
very complex requirements, which are far
too detailed  to go into here.  However,
if your business  clearly generates most
of its revenues from one of the 5 listed
categories, enter "YES", since you might
have a good chance  of qualifying  under
that particular exception to the person-
al holding company tax provisions.

@END