1. Forming a Personal Holding Company
2. Frequently Asked Questions
3. How can I avoid PHC tax implication?
4. How do I calculate my PHC income?
5. What is AGI income?
6. Can I convert from a C corporation to an S corporation?
7. What about bank consolidation groups?
8. What Is a PHC's Adjusted Ordinary Gross Income?
9. What Is the Stock Ownership Requirement?
10. What Is Corporations Filing Consolidated Returns?
11. What Is the Ineligible Affiliated Group?
12. What are the Exceptions to PHC?
13. What Is an Indefinite Maturity Credit Transaction?
14. What Is Included in Business Deductions?

A personal holding company (PHC) is known as 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 the 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 the C corporations that hold on to passive income. Therefore, if a PHC is simply created to hold on to 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 the 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.

What Is a PHC's Adjusted Ordinary Gross Income?

A PHC's general ordinary gross income when adjusted is the same as the corporation's gross income, with the following subtracted: Gains from Internal Revenue Code 1232(b).

  • Specific interest income.
  • Specific expenses that are allowed against royalty income.
  • Specific expenses that are allowed against rental income.
  • Any gains from the disposition or sale of capital assets.

What Is the Stock Ownership Requirement?

During any time of the last part of the taxable year, over 50 percent of the value of the stock that's outstanding is either indirectly or directly owned by no more than five people. A portion of the trust that's set aside permanently or intended to be used only for purposes listed in section 642(c) or a provision that's corresponding for a prior income tax law is considered an individual.

What Is Corporations Filing Consolidated Returns?

In the case where there's an affiliate group of corporations filing or it's mandatory to file consolidated returns under section 1501 for a taxable year, the ordinary gross income that's adjusted has a requirement to be applied for that year. This is with respect to the income of the consolidated personal holding company of the group that's affiliated or the adjusted ordinary gross income that's consolidated. No other member of an affiliated group will be considered to meet this adjusted ordinary gross income with the exception that the affiliated group meets the requirement.

What Is the Ineligible Affiliated Group?

This doesn't apply to a group of corporations that are affiliated if any member of the group, common parent corporations included, receive at least 10 percent or more of their adjusted ordinary gross income for that taxable year from any outside sources. It also doesn't apply if at least 80 percent of the amount is made up of personal holding coming income. Section 543 will be applied to the amount just like it was the adjusted ordinary gross income for the corporation.

What are the Exceptions to PHC?

Any loans to a person that's a shareholder in a company during a taxable year for whom or by at least 10 percent of the value of the outstanding stock is owned indirectly or directly that's outstanding at some point in the year can't exceed $5,000 total in principal amount. However, this doesn't apply if the shareholder of a small business investment company owns, at some time during the year indirectly or directly, at least five percent of proprietary interest. This is for a small business where funds are provided by an investment company or five percent in value is the outstanding stock.

This also applies to a corporation that's subject to the court's jurisdiction of the court in Title 11 or something similar, unless a large purpose of continuing or instituting is to avoid the tax that's imposed from section 541.

What Is an Indefinite Maturity Credit Transaction?

A note, installment obligation, or loan meets the conditions of an indefinite maturity credit transaction if it's made under the agreement where the creditor promises to make advances or loans (that aren't over the maximum amount that was agreed upon) occasionally or for the debtor's account upon request. This must also be under what the debtor is required to pay the advance in full installments or repay the loan.

What Is Included in Business Deductions?

Deductions that can be taken into account can include deductions which are allowed by section 404 or section 162 due to reason. However, there can't be any deduction related to compensation of personal services that were rendered by the shareholders. Deductions are allowed for real property taxes under section 164 and under section 167, but for either case are only to the extent of the property is allowed to be used directly in the regular and active behavior of the finance or lending business. Hiring an attorney can help you figure out what else is included in business deductions.

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