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MODULE 36 TAXES: CORPORATE

of its taxable year. In determining whether the more than 50% stock ownership requirement is met, the constructive ownership rules of Sec. 544 apply. Under these rules, an individual is considered as owning the stock owned by his family including only brothers and sisters, spouse, ancestors, and lineal descendants. Additionally, stock owned by a corporation, partnership, estate, or trust is considered as being owned proportionately by its shareholders, partners, or beneficiaries. Here, Edwards directly owns 240 shares and if he were the beneficiary of an estate that owned 200 shares, Edwards would directly and constructively own 440 shares. Then with four other unrelated shareholders, each owning twenty shares, there would be five shareholders who directly or constructively own 520 shares, more than 50% of the corporation's outstanding stock. 110. (b) The requirement is to determine the status of Arbor Corp. A corporation is a personal holding company (PHC) if (1) five or fewer individuals own more than 50% of its stock during the last half of its taxable year, and (2) at least 60% of its adjusted gross income is derived from investment sources (e.g., dividends, interest, rents). Although the amount of dividends paid to its shareholders may affect the computation of the PHC tax, the amount of dividends paid has no effect on the determination of PHC status. Answer (a) is incorrect because a regulated investment company is a status obtained by registering under the Investment Company Act of 1940, and is not determined by the facts and circumstances present for any given year. Answer (c) is incorrect because the accumulated earnings tax does not apply to personal holding companies. Answer (d) is incorrect because all of Arbor's taxable income is subject to regular federal income tax. 111. (c) The requirement is to determine the maximum amount of accumulated taxable income that may be subject to the accumulated earnings tax for 2009 if Kari Corp. takes only the minimum accumulated earnings credit. Since Kari is a manufacturing company that was first organized in 2009, it is entitled to a minimum accumulated earnings credit of $250,000. To determine its potential exposure to the accumulated earnings tax, its 2009 taxable income of $400,000 must be reduced by its federal income taxes of $100,000 and its minimum accumulated earnings credit of $250,000, to arrive at its maximum exposure of $50,000. 112. (d) The requirement is to determine the amount that Hull, Inc. can deduct for dividends paid in the computation of its personal holding company (PHC) tax: The PHC tax is a penalty tax imposed at a 15% tax rate on a corporation's undistributed personal holding company income. A PHC is allowed a dividends paid deduction that is subtracted from its adjusted taxable income in arriving at its undistributed personal holding company income. Hull's dividends paid deduction consists of the $20,000 of dividends actually paid to its shareholders during 2009, plus the $10,000 of consent dividends reported in its shareholders' individual income tax returns for 2009. Consent dividends are hypothetical divi'dends that are treated as if they were paid on the last day of the corporation's tax year. Since consent dividends are taxable to shareholders but not actually distributed, shareholders increase their stock basis by the amount of consent dividends included in their gross income. The consent dividend procedure has the same result as an actual dividend distribution,

followed by the shareholders making a capital contribution of the dividend back to the corporation. 113. (b) The requirement is to determine the taxpayer to whom the personal holding company (PHC) income will be attributed. A corporation will be classified as a personal holding company if (1) it is more than 50% owned by five or fewer individuals, and (2) at least 60% of the corporation's adjusted ordinary gross income is PHC income. PHC income is generally passive income and includes dividends, interest, adjusted rents, adjusted royalties, compensation for the use of corporate property by a 25% or more shareholder, and certain personal service contracts involving a 25% or more-shareholder. An amount received from a personal service contract is classified as PHC income if (1) some person other than the corporation has the right to designate, by name or by description, the individual who is to perform the services, and (2) the person so designated is (directly or constructively) a 25% or more shareholder. Here, since Benson owns 100% of Lund Corp. and Lund Corp. contra~ted with Magda specifying that Benson is to perform personal services for Magda, the income from the personal service contract will be personal holding company income to Lund Corp. 114. (c) The requirement is to determine the correct statement regarding the personal holding company (PHC) tax. The PHC tax should be self-assessed by filing a separate schedule 1120- PH along with the regular tax Tetu~ Form 1120. Answer (a) is incorrect because the Ij'HC tax is a penalty tax imposed in addition to regular federal income taxes. Answer (b) is incorrect because the PHC tax can only be imposed on corporations. Answer (d) is incorrect because the PHC tax can only be imposed if five or fewer individuals own more than 50% of the value of a corporation's stock. Thus, if a corporation's stock is owned by ten or more. equal unrelated shareholders, the corporation cannot be affiC. . 115. (b) The requirement is to determine the correct statement regarding the accumulated earnings tax (AET). The AET does not apply to corporations that are personal holding companies. Answer (a) is incorrect because the AET can apply regardless of the number of shareholders that a corporation has. Answers (c) and (d) are incorrect because the AET applies to corporations that accumulate earnings in excess of their reasonable business needs and is not dependent upon whether a corporation files a consolidated return or the number of classes of stock that a corporation has. 116. (c) The requirement is to determine the correct statement concerning the personal holding company (PHC) tax. The personal holding company tax may be imposed if at least 60% of the corporation's adjusted ordinary gross income for the taxable year is personal holding company income, and the stock ownership test is satisfied. Answer (b) is incorrect because the stock ownership test is met if more than 50% of the corporation's stock is owned, directly or indirectly, by five or fewer stockholders. Answer (a) is incorrect because the PHC tax is a penalty tax imposed in addition to the regular corporate income tax. Answer (d) is incorrect because the PHC tax takes precedent over the accumulated earnings tax. The accumulated earnings tax does not apply to a personal holding company.