Senator Seeks Repeal of Personal Holding Company Tax

The personal holding company tax was enacted in 1934. It represented an appropriate response to prevent individuals from sheltering investment income from individual income tax by using their closely held US corporations to hold investments. At the time the maximum individual income tax rate was substantially higher than the maximum corporate tax rate and corporations could be liquidated on a tax-free basis. Neither possibility exists today because of changes to the law, yet the provision was never updated to reflect more modern circumstances, particularly those closely held consolidated groups of corporations with foreign affiliates.

In the case of a group of US corporations filing a consolidated return, the PHC test and tax calculation is generally conducted on a consolidated basis. However, in certain circumstances the PHC test and tax computation must be made on a separate company basis. When the test is conducted on a separate company basis, a US group of corporations filing a consolidated return can easily find that it has a personal holding company tax liability even though a great majority of its revenue is generated from the active conduct of its trade or businesses. The net effect is that those companies trapped by the separate company PHC tax computation will decide not to invest such funds in United States infrastructure; but will simply continue to expand their international operations.

The requirement to conduct the PHC tests on a separate company basis therefore often unfairly penalizes corporate groups that are actively engaged in business. I believe the solution is to eliminate the provision (I.R.C. sections 542(b)(2) and (b)(4)) that prevents certain affiliated groups from testing Personal Holding Company (PHC) status on a consolidated basis to the extent that any member of the group derives 10 percent or more of its adjusted ordinary gross income from sources outside the affiliated group (where over 80 percent of such income consists of PHC income).

The fact that PHC provisions have never been updated is particularly troubling in that the PHC tax regime acts as a barrier to US closely held companies desiring to invest dividend income received from foreign operations in their US businesses and infrastructure. PHC just doesn't act as a barrier; it is a discriminatory tax affecting family businesses desiring to invest in the United States. U.S. jobs are also regrettably sacrificed. Closely held companies subject to PHC would like to invest in the United States; however, nobody is inclined to pay this obsolete (15 percent) tax simply because they are privately held. Those funds will stay offshore. There is no logical reason why such closely held corporate entities should not pay the same tax as that of a publicly traded corporation.

This issue has nothing to do with requesting a tax holiday for repatriation. On the contrary, this issue has everything to do with the fact that the PHC separate company tax provision is discriminatory against closely held companies requiring them to pay the additional PHC tax on top of the regular corporate tax that all companies currently pay when they repatriate foreign dividends. I can see no reason why it should unnecessarily and unfairly tax revenues which would otherwise be available for investment in much needed US infrastructure projects or other important uses which would promote economic development.

My question to you is whether the personal holding company tax should be repealed or substantially modified, as suggested above, to reflect modern-day business realities.

I believe that repeal of the personal holding company tax would be a meaningful reform of our tax laws. I look forward to receiving your views on the subject.