What is a Personal Holding Company?

A personal holding company (PHC) is a C corporation formed for the purpose of owning the stock of other companies; therefore, the holding company doesn’t offer products or services but merely owns the shares of other corporations. However, almost all PHCs maintain investment portfolios, which may have significant tax implications should certain criteria be met.

Forming a Personal Holding Company

If your corporation wishes to operate as a PHC, you must pass the following two tests:

  1. The income test
  2. The ownership test

The income test can be met if 60 percent or more of the corporation’s adjusted gross income (AGI) is income from the PHC. This simply means income from investment properties, including dividends, royalties, rent, copyright fees owed to you, interest, and other amounts owed from use of the corporation’s property. However, some exceptions to this list apply, including some royalties that are not considered income for purposes of the income test.

The ownership test can be met if five or fewer individuals own more than 50 percent of the corporation’s stock value at any time during the last half of the tax year. Exceptions to this test also apply. The following types of corporations are excluded:

  • S corporations
  • Tax-exempt corporations
  • Financial institutions
  • Small businesses
  • Corporations that are currently going through bankruptcy

Frequently Asked Questions

  • How can I avoid PHC tax implication?

A PHC tax implication is imposed on a PHC for the undistributed investment income of those C corporations that hold onto passive income. Therefore, if a PHC is simply created to hold onto passive income, then the corporation will be taxed because a corporation should be an active business rather than a shelter for such passive income. Corporations that receive a high level of compensation from investments are targeted, and if a PHC is taxed, it will be charged a 20 percent tax assessment on the undistributed passive income.

It is important to monitor all accrued earnings and types of income received from investments to ensure that your PHC isn’t taxed. Failing to properly identify your PHC’s tax exposure can be an expensive error that can affect the PHC as well as its shareholders.

It is especially important for closely-held corporations to be mindful of the tax implications. Closely-held corporations, which are generally family-created businesses, have very few shareholders. Such closely-held corporations generally collect investment income for the purpose of increasing profits and the owners and shareholders’ net worth. However, a closely-held corporation should be distributing the income rather than maintaining an investment portfolio. Therefore, the undistributed income, which may in fact be all of it, could potentially be taxed. It will be treated as undistributed earnings and tacked on to the regular corporate tax.

Below is an example that may cause tax to be applied to investments held by a PHC:

  • Investment property held and owned by the PHC is destroyed. The PHC then receives insurance proceeds on the destroyed property. Instead of immediately purchasing another piece of property, a significant portion of the insurance proceeds is invested.
     
  • What counts as PHC income?
  • Interest earned
  • Dividends
  • Annuities
  • Royalties
  • Rents
  • Money received for the use of a property that the PHC owns
  • Trust and Estate income
  • Other royalties, including oil, gas, and mineral royalties
     
  • How do I calculate my PHC income?

To calculate PHC income, the federal tax income is altered as follows:

  • Add the dividends deduction you initially subtracted.
  • Limit the net operating loss you deducted to the loss you entered in the previous year. Therefore, if your loss this year was more than in the previous tax year, cap it at the previous amount. 
  • Remove the net capital gains. 
  • Subtract the federal tax liability that is due on the taxable income.
  • Subtract the amount of distributions paid to the shareholders during the year.
  • The resulting number is the corporation’s undistributed PHC income subject to the 20 percent PHC tax.
     
  • What is AGI income?

The PHCs AGI is calculated by taking the corporation’s gross income and subtracting the following:

  • Gains from the sale of capital assets
  • Gains made on property used in the trade or business
  • Certain foreign income
  • Certain expenses allowed against rental income
  • Some types of expenses allowed against royalty income
  • Some types of interest income
     
  • Can I convert from a C corporation to an S corporation?

If you want to convert from a C to an S corporation simply to avoid tax implications, it might not be that easy. An S corporation that has previous C corporation earnings and profit greater than 25 percent of its gross receipts from PHC income sources will be subject to such tax implications, in which a total of 35 percent is applied to the additional net passive income.

  • What about bank consolidation groups?

While PHC tax is usually applied on a consolidated basis (to a consolidated group of companies), certain affiliated companies may not have the tax-exempt protection. For example, in the case of banking institutions, which are exempt from such tax implications, those affiliates of the bank are not necessarily exempt. Therefore, the PHC tax rules are applied individually to each affiliate as though it does not operate within the consolidated group of companies.

In addition to banks, other PHC exempt entities include thrift shops, finance or lending companies (if having met certain criteria). This creates a great degree of risk for those affiliated companies that earn a profit from investments, such as a bank holding company that bears its own investment portfolio.

If you need additional help learning more about forming a personal holding company, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Stripe, and Twilio.