1. Personal Holding Company Chapter 45 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company1 A personal holding company is a corporation that must meet two tests, and is not specifically excluded from such status –Stock ownership test –An income test Through 2012, the personal holding company tax is imposed at a rate of 15% of undistributed personal holding company income, in addition to the regular corporate income tax and AMT tax What Is A Personal Holding Company?

2. Personal Holding Company Chapter 45 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company2 If assets in the corporation appreciate there will be 2 taxes: –Corporate level (upon sale of the assets or liquidation) –Shareholder level (upon liquidation or dividend distribution) What Is A Personal Holding Company?

3. Personal Holding Company Chapter 45 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company3 Stock Ownership Test –Corporation meets the requirement if: –50% in value of its outstanding stock is owned directly or indirectly by or for not more than 5 individuals at any time during the last half of the taxable year Income Test (60% Test) –At least 60% or more of the corporation’s adjusted ordinary gross income is personal holding company income Dividends, interest, certain royalties, rents or amounts received in return for certain personal services What Is A Personal Holding Company?

4. Personal Holding Company Chapter 45 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company4 Want to reduce federal estate taxes attributable to a large estate consisting of highly appreciated and readily marketable securities To reduce the value of an estate through court approved methods for discounts Desire gift and estate tax savings for appreciated assets, while retaining economic control and flexibility in making economic decisions –Consider other alternatives that can achieve the same result without double taxation When Is Use Of A Personal Holding Company Appropriate?

5. Personal Holding Company Chapter 45 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company5 A corporation is formed by an individual who owns a substantial amount of appreciated property Individual transfers a portfolio of common stock of various companies to the new closely-held corporation, in return for its stock No recognition of gain on the transfer if –Transferor controls 80% of the voting power and 80% of each class of stock immediately after the transfer What Are The Requirements?

6. Personal Holding Company Chapter 45 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company6 Basis in the new company stock will equal the basis of the property transferred to the corporation Corporation will receive individual’s basis on the property transferred to the corporation What Are The Requirements?

7. Personal Holding Company Chapter 45 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company7 How Is It Done? Transfer $1,000,000 Closely-Held Stock to PHC Receive $200,000 PHC Voting Common Stock Individual Donor Personal Holding Company Closely- Held Highly Appreciated Company Stock FMV $1,000,000 Child 1 Child 2 Child 3 Receive $800,000 PHC Non-Voting Common Stock Make annual gifts of discounted non- voting shares over a period of years

8. Personal Holding Company Chapter 45 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company8 Example: –Main objective to maintain control, while making gifts to limit future appreciation in the value of the individual’s estate –Individual forms a personal holding corporation and retains 100% of its stock –Individual transfers highly appreciated stock in a closely-held corporation with FMV of $1,000,000 to the personal holding company –The personal holding company is capitalized: $800,000 FMV of non-voting common stock issued to the donor-individual, and $200,000 FMV of voting common stock also issued to the donor-individual How Is It Done?

9. Personal Holding Company Chapter 45 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company9 Example: –The individual then makes gifts of the $800,000 of non- voting common stock to family members utilizing annual exclusions and her unified credit exemption equivalent over a period of years –Because the non-voting stock represents most of the right to the financial growth of the business, substantial appreciation is removed from the individual’s estate –An additional benefit may be that the stock in the corporation used to hold the assets is worth less than the value of the assets owned by the corporation Allowing discounts in the value of the corporate stock to be taken for gift tax purposes How Is It Done?

10. Personal Holding Company Chapter 45 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company10 Substantial estate and gift tax savings may be possible through discounts in the valuation process Individual forming the personal holding company can perform bona fide services for it and receive a salary taxed at a maximum rate of 35% through year 2012. Compensation is fully deductible by the corporation –Excess compensation would be taxed at the individual level Tax Implications

11. Personal Holding Company Chapter 45 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company11 Taxable income of the corporation can be lowered further by providing fringe benefits to a working stockholder and working members of his family –Qualified pension –Profit-sharing –Certain medical expenses A capital loss of a corporation can be carried back up to three years to offset prior capital gain income Tax Implications

12. Personal Holding Company Chapter 45 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company12 Potential for double taxation if the personal handling company is not properly handled Imposition of state franchise tax on the value of the personal holding company stock or remaining value in the corporation each year Tax Implications

13. Personal Holding Company Chapter 45 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company13 It is possible to transfer life policies along with other assets to the personal holding company in exchange for voting common stock Alternatively, the holding company could purchase life insurance on the holder of the voting stock Life Insurance

14. Personal Holding Company Chapter 45 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company14 By then giving non-voting common stock to the donee-family members, most of the appreciation due to the death value of the insurance can be transferred out of the donor-owner’s estate Decedent’s executor can direct the corporation to make an IRC Section 303 stock redemption to provide the estate with liquidity Life Insurance (cont’d)

15. Personal Holding Company Chapter 45 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company15 Ownership of one spouse will be attributed back, regardless of whether the spouse’s interest is community or separate property For estate planning, a community property interest is advantageous because of the step-up in basis on both halves on the death of one spouse Classification of income is critical, since 60% must be from personal holding company income Issues In Community Property States

16. Personal Holding Company Chapter 45 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company16 Absent an agreement to the contrary, if the stock ownership is community property, the income will be community property It is important to be able to show that the profits from and appreciation in value of the business are from one (or both) spouse’s efforts in order to spread the increased value between the two estates and receive the step-up on both halves at the first death Issues In Community Property States