2009 CCH. All Rights Reserved.
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.” The differences between the two taxes
should be emphasized. Imposition of the accumulated earnings tax is subjective and depends on why earnings
are accumulated. A liberal exemption exists, the greater of $250,000 (sometimes $150,000) or “reasonable
business needs,” 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 de
ciency 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
ve 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.”
¶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 de
nite 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 speci
c business. The
formula should be covered in detail since it establishes an accepted,
objective measure of working capital needs. “Bad” 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