1. The Code contains a number of provisions designed to curb certain tax avoidance schemes. Several of these provisions deal with controlled groups of corporations.
2. A controlled group can be a parent-subsidiary group or a brother-sister group. A parent-subsidiary group is where at least 80% of the voting power or value of stock of each corporation in the group (other than the common parent) is owned by one or more corporations in the group. A brother-sister group exists when 5 or fewer persons own at least 80% of the voting stock or value of stock of each corporation’s stock in the group, and 5 or fewer individuals own at least 50% identical interests in each corporation (i.e., the lowest common denominator of ownership is used in each corporation).
3. Limitations imposed on controlled groups are as follows:
4. Affiliated groups do receive one favorable tax benefit; the normal 70% or 80% dividends received deduction is increased to 100% for dividends received from an affiliated corporation. Members of an affiliated group are not required to adopt the parent’s tax year.
5. Accumulated Earnings Tax – A corporation may be subject to a 15% rate penalty on unreasonable accumulations of surplus that are not explained by reasonable business needs; this penalty is designed to encourage corporations to pay dividends. Each corporation is allowed a $250,000 minimum accumulated earnings credit that is exempt from the tax ($150,000for personal service corporations) if this amount exceeds the reasonable business needs of the company.
6. Personal Holding Company (PHC) Tax – If 5 or fewer persons control, directly or indirectly, more than 50% of the outstanding stock of a company and at least 60% of the company’s income is personal holding company income (passive investment types of income), then the company may have to pay a PHC tax of 35% on any personal holding company income (undistributed passive incomes).
7. Personal Services Corporations (PSC) - A personal services corporation exists when substantially all of the activities of the company involve the performance of personal services and at least 95% of the corporation’s stock (by value) is owned directly or indirectly by (1) employees furnishing services, (2) retired service employees, (3) an estate of either category above, and (4) any person acquiring the stock of a person in either category if measured within 2 years of the employee or former employee’s death. A corporation meeting the PSC definition is subject to the passive activity rules of Sec. 469, and is taxed at a flat 35% rate (see below).
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