Personal Holding Company (PHC)

A “Personal holding company” (PHC) is the status applied to a qualifying C-Corporation for the purpose of tax assessment. A special tax exists to levy tax on the undistributed income of C-corps that are deemed to be serving as vehicles to shelter passive income.

Taxpayers may be tempted to take advantage of the lower income tax rates applied to corporations by accruing earnings in a corporation instead of as an individual. A corporation will be considered a personal holding company if it meets both the Income Test and the Stock Ownership Test.

• The Income Test states that at least 60% of the corporation’s adjusted ordinary gross income for the tax year is from certain dividends, interest, rent, royalties, and annuities.
• The Stock Ownership Test states that at any time during the last half of the tax year, 5 or fewer individuals must directly or indirectly own more than 50% in value of the corporation’s outstanding stock.

The law targets C-corps that derive more than 60% of their AGI from investments or other unearned income:

• Stock Dividends
• Interest minus certain amounts excluded under Internal Revenue Code 543(a)(1) and Internal Revenue Code 543(b)(2)(C)
• Royalties minus certain expenses allowed under Internal Revenue Code 543(b)(2)(B)
• Rents
• Annuities
• Trust income
• Oil, mineral, gas, and copyright royalties subject to specific income requirements

PHC tax is currently a flat 20% rate applied to undistributed corporate income.

Mr. Client inherits shares of his grandfather’s C-Corp along with his brothers. The C-Corp owns a medium sized local real estate portfolio and produces significant monthly free cash flow after expenses. As there are only 4 brothers, and all of the company’s income comes via real estate rents, Mr. Client’s accountant advises him that he and his brothers should distribute all of the companies income to avoid having company AGI being subjected to personal holding company (PHC) tax. After discussing this development with his brothers they agree that a chapter C corporation is not the best ownership structure for the real estate, and along with the family accountant start planning its transition into a new ownership structure.