Accumulated Earnings and Personal Holding Company Taxes
SUMMARY OF CHAPTER
Both the accumulated earnings tax and the personal holding company tax serve the same broad objective: to
encourage dividend distributions and enforce “double taxation.Ä The differences between the two taxes should be
emphasized. Imposition of the accumulated earnings tax is subjective and depends on why earnings are accumu-
lated. A liberal exemption exists, the greater of $250,000 (sometimes $150,000) or “reasonable business needs,Ä
both reduced by accumulated earnings last year. The tax is based on annual taxable income, with adjustments,
although accumulated earnings play an important part. The tax has been applied to public companies. There is no
ownership control test.
The personal holding company tax is objective and depends on numerical tests, more-than-50-percent control
and at-least-60-percent passive income. The tax is self-assessed, imposed on undistributed PHCI on an annual basis,
but is rarely paid because of the deficiency dividend option, unique to the PHC tax. (The consent dividend
procedure is available to eliminate or reduce both taxes.) No credit is available. The tax rate for the personal
holding company tax, 15 percent, is the same as for the accumulated earnings tax. The tax is imposed only on
corporations controlled by five or fewer individuals.
Accumulated Earnings Tax
¶18,001 Rate and Nature of Tax
The accumulated earnings tax is imposed on accumulated earnings “beyond reasonable business needs.Ä
¶18,015 Basis for Liability
Rarely assessed, the accumulated earnings tax is only applicable, as a practical matter, when a corporation has
large accumulated earnings invested in liquid assets and cannot demonstrate a good business reason for not
distributing its earnings as taxable dividends.
¶18,025 Tax-Avoidance Purpose
One of the requirements for a corporation to be subject to the accumulated earnings tax is that the corporation
be formed or availed of for the purpose of avoiding income tax being imposed on its shareholders or the
shareholders of another corporation.
¶18,035 Reasonable Needs of the Business
Once accumulated earnings exceed $250,000 ($150,000 in the case of certain service corporations), the
business must be prepared to show a definite and feasible plan for the funds. The typical reasons include business
expansion, reserves for product liability, and working capital. However, individual reasons are only limited by the
situation of the specific business. The
formula should be covered in detail since it establishes an accepted,
objective measure of working capital needs. “BadÄ facts include shareholder and family member loans and liquid
assets invested in assets unrelated to the business.
¶18,045 Computing the Amount of the Accumulated Earnings Tax