The PHC rules are complex, but the basic intent is to penalize any PHC  that does not distribute the "appropriate" amount to its shareholders during a taxable year.

Taxpayers never have to face a decision about whether or not to elect treatment as a Personal Holding Company (PHC) - the IRS has already made that decision, treating a corporation as a PHC if it meets the following criteria:

Ÿ at least 60% of its income is classified as PHC income (income from dividends, interest, and gains on sale of stock),

Ÿ at least 50% of the value of its outstanding stock is owned - directly, or indirectly - by five or fewer individuals at any time during at least one half of the tax year.

In the interest of ensuring that individual taxpayers do not escape or delay exposure to income tax by keeping their investment income inside a corporation, the IRS burdens PHCs with a few special rules concerning distribution of income.

The PHC rules are complex, but the basic intent is to penalize any PHC that does not distribute the "appropriate" amount to its shareholders during a taxable year. PHC's deemed by the IRS to distribute less than the appropriate amount are subject to a 39.6% penalty on the amount so deemed to be under-distributed, as calculated below:

CALCULATION OF THE PHC TAX

Taxes

Charitable Contributions

Net Long-term Capital.Gains in excess of Short-term Capital Losses

Dividends Paid during the year

equals: Undistributed PHC Income

times 39.6%

equals: Personal Holding Company Tax

How to properly manage the activities of a PHC

If an insufficient amount of income is distributed during the year, the taxpayer can distribute additional amounts after the end of the year, but before the initial tax return due date. While this can reduce the potential penalty, there are stringent limits on the amount of such post-year-end distributions (not in excess of 20% of actual yearly dividends distributed).

Suffice it to say that the rules surrounding PHCs are complex and - if not understood properly - can result in significant tax penalties. DMS understands these rules - we have PHCs as clients and know how to navigate around the very complex rules and avoid any penalty. The professionals at DMS would be happy to answer any questions you may have concerning PHCs.

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