1. Accumulated Earnings and Personal Holding Company Taxes ©2008 CCH. All Rights Reserved. 4025 W. Peterson Ave. Chicago, IL 60646-6085 1 800 248 3248 www.CCHGroup.com

2. CCH Federal Taxation Comprehensive Topics 2 of 17  Broad objective – encourage dividend distributions and enforce double taxation.  15% tax for both  Accumulated Earnings tax – subjective and focuses on ‘why’ earnings are being accumulated.  Personal Holding Company tax – objective and depends on numerical tests. Overview Chapter 17, Exhibit 1b

3. CCH Federal Taxation Comprehensive Topics 3 of 17  Assessed on accumulated earnings ‘beyond reasonable business needs’.  Rarely assessed.  If accum earnings > $250K, the business must have a definite, feasible plan for the funds. Accumulated Earnings Tax Chapter 17, Exhibit 1b

4. CCH Federal Taxation Comprehensive Topics 4 of 21 Accumulated Earning Tax (AET)—Overview Definition. The AET is a 15% penalty tax imposed on corporations that accumulate earnings and profits above and beyond reasonable business needs. Purpose. To prevent C corporations from avoiding income tax at the shareholder level by accumulating rather than distributing excess earnings and profits. Excluded corporations include:  S corporations  Personal holding companies  Passive foreign investment companies  Tax-exempt organizations Chapter 18, Exhibit 1a

5. CCH Federal Taxation Comprehensive Topics 5 of 21 Determination. AET liability is generally determined by the IRS only on an audit. A corporation does not file a form to compute AET with its annual income tax return. AET Base. The 15-percent accumulated earnings tax is imposed on a corporation's accumulated taxable income. Accumulated Earning Tax (AET)—Overview Chapter 18, Exhibit 1b

6. CCH Federal Taxation Comprehensive Topics 6 of 21 AET Base Computation—Dividends-Paid Deduction Only amounts that could have been distributed as dividends are subject to the AET penalty. As a result, the AET base is reduced by the following dividends:  Actual dividends. Dividends paid during the year.  Throwback dividends. Dividends distributed within 2 ½ months after year-end but taxable currently as ordinary income.  Consent dividends. Amounts the shareholders agree to be taxed on even though not distributed. As a result, the shareholder is deemed to have received the dividend, then to have contributed to the capital of the corporation. Stock basis increases accordingly. Chapter 18, Exhibit 3

7. CCH Federal Taxation Comprehensive Topics 7 of 21 AEC is not actually a credit. It is a reduction of the accumulated taxable income to reflect the reasonable needs of the business. AEC is the greater of:  General credit. The portion of retained current E&P for reasonable needs of the business, or  Minimum floor. The statutory amount (generally $250,000) less accumulated E&P at the close of the preceding year. Chapter 18, Exhibit 4a AET Base Computation—Accumulated Earnings Credit (AEC)

8. CCH Federal Taxation Comprehensive Topics 8 of 21 AET Base Computation—Accumulated Taxable Income Accumulated taxable income is a corporation's taxable income, with certain adjustments, minus the dividends-paid deduction and accumulated earnings credit. Chapter 18, Exhibit 2a

9. CCH Federal Taxation Comprehensive Topics 9 of 21 Reasonable Needs. Reasonable needs of a business include those items that a corporation requires to meet the future needs of the business and for which there are specific, definite and feasible plans for use. Chapter 18, Exhibit 4b AET Base Computation—Accumulated Earnings Credit (AEC)

10. CCH Federal Taxation Comprehensive Topics 10 of 21 AET Base Computation—Accumulated Earnings Credit (AEC) Reasonable needs include:  Working capital  Raw material purchases  Equipment updates  Expansion of production facilities  Retirement of business debt  Redemption of stock from a deceased shareholder’s estate  Reserves for product liability  Realistic business contingencies  Acquiring a related business  Investments or loans to key suppliers or customers Chapter 18, Exhibit 4c

11. CCH Federal Taxation Comprehensive Topics 11 of 21 Unreasonable Needs. The following are generally not considered reasonable needs of a business. Any of them may trigger the AET penalty.  Funding plans to declare a stock dividend  Funding plans to redeem a living shareholder’s stock  Unrealistic business hazard protection  Investment in property unrelated to the business  Loans to shareholders Chapter 18, Exhibit 4d AET Base Computation—Accumulated Earnings Credit (AEC)

12. CCH Federal Taxation Comprehensive Topics 12 of 21 Personal Holding Company Tax (PHC Tax) Definition. The PHC tax is a 15% penalty tax imposed on corporations that accumulate predominantly investment-type income (other than capital gains). Corporations are subject to the PHC tax if:  Not more than 5 individuals directly or indirectly own over 50% of the total stock based on fair market value; and  Not less than 60% adjusted ordinary gross income is personal holding company income. Purpose. To prevent an individual from transferring dividend-paying investments to a corporation and then using the dividend received deduction to avoid taxable income. Chapter 18, Exhibit 5a

13. CCH Federal Taxation Comprehensive Topics 13 of 17  Must have fewer than 5 individuals, control more than half the stock, income test(60% passive), corp files PHC return.  Discourage tax avoidance  Tax is assessed on undistributed personal holding company income.  Many excepted corporations including tax-exempt, banks, life insurance, S-corps, etc.  Deductible to arrive at tax base includes dividends paid during tax year, div paid within 2 ½ months of year end, consent div, deficiency div, dividend carryover Personal Holding Company Chapter 17, Exhibit 1b

14. CCH Federal Taxation Comprehensive Topics 14 of 21 Personal Holding Company Tax (PHC Tax) Excluded corporations include:  S corporations  Foreign corporations  Tax-exempt organizations  Banks  Life insurance companies Chapter 18, Exhibit 5b

15. CCH Federal Taxation Comprehensive Topics 15 of 21 Personal Holding Company Tax (PHC Tax) Determination. Unlike AET, PHC liability is generally determined by self-assessment, rather than through an IRS audit.  Schedule PH is filed with Form 1120 by a PHC.  There is a six-year statute of limitations if the schedule is not filed. Chapter 18, Exhibit 5c

16. CCH Federal Taxation Comprehensive Topics 16 of 21 Personal Holding Company Tax (PHC Tax) Undistributed Personal Holding Company Income (UPHCI). The PHC tax is 15% of UPHCI. UPHCI is taxable income, net of specific adjustments and a dividend-paid deduction. Chapter 18, Exhibit 5d

17. CCH Federal Taxation Comprehensive Topics 17 of 21 Undistributed PHC Income Computation— Specific Adjustments to Taxable Income UPHCI is taxable income, net of specific adjustments and a dividends-paid deduction. Chapter 18, Exhibit 6a

18. CCH Federal Taxation Comprehensive Topics 18 of 21 Undistributed PHC Income Computation— Dividends Paid Deduction In computing undistributed personal holding company income, taxable income is reduced by five possible types of distributions attributable to E&P. 1. Actual dividends. Dividends paid during the year to the extent of E&P. 2. Throwback dividends. Dividends distributed within 2 ½ months after year-end but taxable currently as ordinary income. 3. Consent dividends. Amounts the shareholders agree to be taxed on even though not distributed. As a result, the shareholder is deemed to have received the dividend, then to have contributed to the capital of the corporation. Stock basis increases accordingly. Chapter 18, Exhibit 7a

19. CCH Federal Taxation Comprehensive Topics 19 of 21 Undistributed PHC Income Computation— Dividends Paid Deduction 4. Deficiency dividend. A PHC is allowed 90 days to pay a deficiency dividend to its shareholders after a determination of PHC tax liability is made.  The PHC must elect to apply it to the year of liability.  Interest and penalties otherwise imposed still apply. 5. Dividend carryover.  Dividends actually paid may be carried over and deducted over the next 2 years to the extent they exceed adjusted taxable income.  Adjusted taxable income is undistributed personal holding company income prior to dividends-paid deduction. Chapter 18, Exhibit 7b