628 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 cor-
poration, partnership, estate, or trust is considered as being
owned proportionately by its shareholders, partners, or bene-
ficiaries. 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 in-
vestment 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. An-
swer (a) is incorrect because a regulated investment com-
pany 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 incor-
rect 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 corpora-
tion's tax year. Since consent dividends are taxable to
shareholders but not actually distributed, shareholders in-
crease their stock basis by the amount of consent dividends
included in their gross income. The consent dividend proce-
dure 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 in-
come 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. con-
tra~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 sepa-
rate 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 be-
cause the PHC tax can only be imposed if five or fewer indi-
viduals 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 depen-
dent 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. An-
swer (b) is incorrect because the stock ownership test is met
if more than 50% of the corporation's stock is owned, di-
rectly or indirectly, by five or fewer stockholders. An-
swer (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 earn-
ings tax does not apply to a personal holding company.