Determining whether personal service income is PHC.

• Author: Ellentuck, Albert B.
• Position: Personal holding company - Case study

Facts: Bob, a financial consultant, contracts with financially troubled businesses to provide controllership, treasury and CFO services in an effort to rehabilitate these concerns. In 1993, Bob incorporated his business Under the name of FSC, Inc., receiving 100% of the stock. As a result of his efforts, FSC landed a contract with CPN, a residential construction firm. The contract provided that Bob would act as CPN's controller for a period of six to 18 months. He was also named to renegotiate loan agreements with lenders and perform other services similar to those of a CFO. The contract lasted until Jan. 13,1999, when CPN filed for bankruptcy. * FSC received $100,000 of income from CPN in 1998. Expenses attributable to this income included $25,000 in salary paid to Bob; $60,000 paid to other staff members for bookkeeping, budgeting and controllership services; and $15,000 of overhead. Additionally, in 1998, FSC received $15,000 of income from other sources; related expenses were $12,000. * In February 1999, FSC began providing tax return preparation and bookkeeping services. Bob provided services for approximately 50 clients without written contracts or engagement letters. No other services were provided in 1999. * Revenues collected from the return preparation and bookkeeping services during 1999 were $65,000; no fees were collected from CPN. Expenses included Bob's salary of $40,000 and overhead of $15,000. The corporation intends to use the $10,000 of net income to purchase computers. Issue: Is the income from the CPN contract personal holding company (PHC) income? Is the income from the tax return and bookkeeping services PHC income?

Analysis

Income from personal services is included in PHC income to prevent tax avoidance by persons with unique talents (e.g., actors and professional athletes). By incorporating the business, an individual can assign income from personal services to the corporation, with the corporation retaining a portion of the fees it receives for the services, thus subjecting some of the income to the lower graduated corporate tax rates. Income from personal services is included in PHC income if.

1. Either the individual providing the services is designated (by name or other description) in the contract (or someone other than the corporation has the right to so designate) and

2. The designated person owns (directly or indirectly) at least 25% in value of the outstanding stock at any time during the corporation's tax...