If more than 50% in value of a corporation’s stock is owned directly or indirectly by not more than five individuals at any time during the last half of its tax year (the last half of 2014 for a calendar year corporation), the corporation should check its estimated income for the tax year to make sure it isn’t a personal holding company (PHC). Undistributed PHC income is taxed at a flat rate of 20%. Generally speaking, undistributed PHC income is taxable income subject to certain adjustments and reduced by the dividends-paid deduction. The dividends-paid deduction includes, among other things, dividends paid during the tax year, consent dividends and late-paid dividends.

PHC classification generally results if a 50% stock ownership test is met and 60% or more of the corporation’s adjusted ordinary gross income (AOGI) is PHC income.  PHC income includes, among other items, interest, dividends, rents and royalties. However, rents are excluded from PHC income classification if the total rents, after being reduced by depreciation, taxes, interest and rent expenses, are 50% or more of the corporation’s AOGI, but this exclusion for rents doesn’t apply if the corporation has dividends, interest and certain other PHC income (net of distributions) totaling more than 10% of its ordinary gross income.

M&Q Caution: During years of recession and/or sluggish recovery, a corporation’s business income may drop relative to PHC income, causing a closely held corporation inadvertently to be at risk for the PHC tax.

M&Q Recommendation: If the corporation is in danger of falling into the penalty class, check whether it is possible to shift income before the end of the corporation’s tax year so as to take the corporation out of this classification. For example, if a calendar year corporation’s PHC income is at or over the 60% mark, accelerating business income from 2015 to 2014 may drop the PHC income below 60%. Or PHC income may be deferred to 2015 as a means of cutting the 2015 percentage, e.g., by deferring interest through the use of short-term instruments.