Question

Omar, an individual in the 37% tax bracket, wants to shift some of his income to a new corporation in order to take advantage of the 21% corporate tax rate. Omar plans to avoid any tax on dividends by retaining all earnings within the corporation. Will Omar's plan work?

Omar's ability to achieve tax savings by shifting income to a corporation may be limited by __________ . Omar could be subject to a_______ % penalty tax on ______ the corporation.

Answer 1

Omar's ability to achieve tax savings by shifting income to a corporation may be limited by (either AET or PHC)(1) . Omar could be subject to a (20 %)(2) penalty tax on (undistributed profit retained by)(3) the corporation.

Explanation:

1) the personal holding comoany (PHC) tax was enacted to discourage the sheltering of certain kind of individuals with high marginal tax rates. like the accumulated earning tax,the PHC tax employ forces the corporation to distribute earning to sharholders.

2)The accumulated earnings tax imposes a 20 percent tax on the current year’s corporate earnings as per reasonable businees needs.

However, in any single year, the IRS cannot impose both the PHC tax and the accumulated earningGenerally, a company is considered a PHC and may be subject to the tax if:

a)More than 50 percent of the value of the outstanding stock is owned by five or fewer individualsyear, and

b)A substantial portion (60 percent or more) of the corporation’s income is comprised of passive tyinterest, rents, royalties, or certain personal service income.

Omar's ability to achieve tax savings by shifting income to a corporation may be limited by either the personal holding company (PHC) tax. The AET and PHC tax are designed to prevent corporationthe double tax on dividend distributions. Both provisions impose a 20% penalty tax on undistributed.Thus, Omar's tax savings will be dependent on whether either of these taxes apply.