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REG CPA Practice Questions: Personal Holding Companies
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May 3, 2024
In this video, we walk through 5 REG CPA exam practice questions teaching about personal holding companies and the taxes that apply to them. Important Links Link to the free study training webinar mentioned in the video: https://www.superfastcpa.com/strategic-study See the full post for this video: https://www.superfastcpa.com/reg-cpa-practice-questions-explained-personal-holding-companies/ See the other REG walkthrough videos here: https://www.superfastcpa.com/free-reg-cpa-practice-question-walkthroughs/ 00:00 Intro 00:49 Question 1: Learning the Personal Holding Company Requirements 02:59 Question 2: Applying the Requirements 04:08 Question 3: The Personal Holding Company Tax 05:58 Question 4: Applying the PHC Tax 06:52 Question 5: Determining PHC Status and PHC Tax Liability 08:48 Pillar Topics
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Welcome to another reg walkthrough video. I'm Logan, and in today's video, we're going to be going
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over personal holding companies. And we're going to be doing that, the Super Fast CPA way
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which is diving straight into questions to learn the material. If you don't know much about our
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strategies, and if you want to learn more, make sure you go to superfastcpa.com and check out our
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free one-hour webinar training. We go over the key ingredients to passing the CPA exam. Again
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it's one hour, it's free, it will save you so much time in your study process. The link will be in the
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description and it will look like this. Also, if you like the idea of going through questions to
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learn the material, be sure to check out our Superfast CPA app where we not only have audio notes
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and review notes, but we also have five question mini quizzes that you can easily access on your
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phone all throughout your day to continually be practicing. With all that said, let's dive straight
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into the questions. All right, here's the first question. ABC Corp is a C corporation with various
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income streams and ownership patterns. For the tax year, ABC Corp reports the following. Dividend income of
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$120,000, interest income of $80,000, rental income from an active management of properties
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of $50,000, retail sales income of $300,000, and also the corporation is owned by five individuals
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each holding an equal share. Given the information, which of the following is the most accurate
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regarding ABC Corp's status as a personal holding company or PHC? Okay, if you are watching this
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video and you have no idea what a PHC is, that's okay, that's why we're here. Let's go straight
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into the answer and learn how this works. Okay. So the answer is C. ABC Corp does not qualify as a
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PHC because the passive income does not exceed 60% of its total income. Okay, so apparently those are
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some of the rules. Let's go ahead and read the explanation. A corporation qualifies as a personal
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holding company or PhDC if it meets specific ownership and income criteria. More than 50% of its
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outstanding stock must be owned by five or fewer individuals during the last half of the tax year
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Additionally, at least 60% of its adjusted ordinary income must come from passive sources
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such as dividends, interest, excluding interest from certain active businesses, or even tax-exempt
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interest, rents unless from an active real estate business, royalties, and annuities
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These requirements aim to prevent closely held corporations from avoiding tax on passive income
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by deferring distributions to shareholders. If these conditions are met, the corporation is subject to PHC tax on its undistributed
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PHC income to encourage these distributions And we will go over what the PHC tax is in a few questions So in this case the passive income of is approximately 36 of the total income of
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or else it does not meet the 60% threshold. So even though it is owned by five individuals and it does have passive income
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it doesn't qualify as a PHC because not enough of its total income is considered passive
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All right, let's go ahead and go to the next question to learn more about this. Okay, here's question two. Pinehurst Holdings is a C corporation which reports the following income for the tax year
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Dividend income of $200,000, interest income from corporate bonds of $150,000, rental income from non-active properties of $75,000, manufacturing income of $175,000
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Also, the corporation is owned by four cousins, each holding an equal share. Given this information, does Pinehurst Holdings qualify as a personal holding company
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Okay, we learned about the requirements in the previous question, so take a second, pause the video if you need to, and when you're ready, come back, and we will look at the answer to see if you got the right answer
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Okay, the answer is yes, because it meets both the ownership and income requirements for a PHC
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So the ownership requirement is met because five or fewer people own more than 50% of the company
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It also meets the income requirements since the passive income is a total of $425,000, which is just above 60% of the company
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the total income of $700,000. So now we've seen two situations, one where it was considered a
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PHC and one where it wasn't. Now let's go ahead and figure out what happens if it is considered
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a PHC. And here is question three. Gardena Enterprises is a C corporation and has been identified
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as a personal holding company for the current tax year. The corporation reports the following
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Total taxable income of $800,000 and dividends paid during the year of $300,000. Based on this
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information calculate the PHC tax liability for Gardinia Enterprises. Okay, how do we calculate the tax
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liability for a PHC? Let's go ahead and look at the answer to learn how this works. Okay, so the correct
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answer is $100,000. So let's learn about it. There is an additional 20% tax on undistributed
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net income for personal holding companies. This serves as a punitive measure designed to encourage the
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distribution of earnings to shareholders. There is also something called the dividends paid deduction. This is
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also designed to encourage P.HCs to distribute their profits to shareholders. Since PHCs are
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typically closely held entities, there is a tendency for such companies to retain earnings to defer
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or avoid paying individual income taxes at potentially higher rates The dividends paid deduction mitigates this by reducing the PHC taxable income by the amount of dividends it distributes So let see what this calculation looks like So to calculate it first we have to take the total taxable income and do that dividends
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paid deduction. So they end up with $500,000 of net taxable income. And then you apply 20%. And that is
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the rate right now and that's how it's been for a while. So unless that changes soon, typically it's
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20% for PhDs, you use that 20% to calculate the PHC tax liability. So $100,000 because that's
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$20% of $500,000. So essentially, if a company is a PHC and they don't distribute all of their
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net income, whatever they don't distribute is taxed at a 20% tax rate as an additional tax liability
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But they can avoid that by distributing that net income as dividends. Okay, we learned about that
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Let's go ahead and go to the next question to add on to it. Okay, here's question four. Maple Leaf Enterprises, a recognized personal holding company, reported a taxable income of $400,000 for the tax year
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During the same period, Maple Leaf Enterprises paid $150,000 in dividends to its shareholders
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Assuming the PHC tax rate is 20%, which, again, that's what it typically is
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calculate the PHC tax liability for Maple Leaf Enterprises. Okay, you just learned how to do this
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It's pretty easy, so if you need to pause the video, calculate it, and when you're ready, come back
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and we will look at the answer together. Okay. $50,000, you probably calculated that just fine
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So first, you calculate the total undistributed net income, which is this $400,000 less the $150,000 dividends distributed
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and then you multiply that by 20%, and that gives you an extra $50,000 tax liability
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because they're a personal holding company. Okay, let's go to one last question to put it all together
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Okay, here is question five. Willowbrook, Inc. is a C corporation with the following income and ownership details for the
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tax year. So they had total taxable income of $500,000, and that included dividend income of $200,000
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interest income from corporate bonds of $100,000, rental income from non-active properties of $50,000
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and consultancy income of $150,000. They also paid $250,000. The corporation is owned by three
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brothers, each holding an equal share. So first, we need to determine if Willowbrook, Inc
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qualifies as a personal holding company and then we need to calculate the
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PHC tax liability if applicable and again we assume the PHC tax rate is 20%
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So take a second this is the last question in the video you've learned how to do
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this you should know how to do this by now So go ahead pause the video figure it out and when you ready come back and we will look at the answer Okay and the answer is that it is a PHC with an additional tax liability of So first you have to determine the PHC status and it does meet the ownership test because more than 50 is owned by five or fewer people
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and that's the three brothers in this case. And then it also meets the income test because if you add up all the dividends, interest, and non-rential income
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that equals $350,000, and divide the $500,000 of total income by that, and you get $70,000
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percent of the income being passive, so it also meets that requirement. So we know that this is a
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personal holding company. And because it is a personal holding company, we take whatever amount of that
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$500,000 that was not distributed, and they distributed $250,000 of it, leaving $250,000, and that amount is
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taxed by the 20%, giving you $50,000 of PHC tax liability. All right, that was the last question
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It's not a super difficult topic once you know the requirements and the percentage for the tax liability
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Let's go ahead and do one last part of the super fast CPA strategy to finish out this video called Pillar Topics
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Now, the idea behind Pillar Topics is as you're going through the questions to learn the material
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and even after you've gone through the questions, you take a second and you think about the things that you learned in those questions
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What were the topics that continually came up all throughout the questions
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You know, what are the three or four things that are obviously important according to my review course based on the questions that I just did
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So let's go ahead and look at the pillar topics for this video. Okay, and here are the pillar topics
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First off, a C corporation is considered a personal holding company if more than 50% of it is owned by five individuals or less
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and if 60% or more of its gross income is passive, and that would be things like interest, dividends, non-active rent, etc
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If it is considered a PHC, any net income that is not distributed as dividends to its shareholders is taxed at an additional 20%
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So that gives them an incentive to take advantage of the dividends distributed deduction to avoid this additional tax liability
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And again, to remind you of that, if they distribute dividends to their shareholders, those amounts are not taxed the extra 20%
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And that's pretty much it. Again, not a super difficult topic once you know how to do it
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And those are the pillar topics. Thanks for watching this video. one more reminder to go check out our free one-hour webinar training on superfast cpa.com
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and if you liked going through the questions to learn the material make sure you check out our superfast CPA app to see our five question mini quizzes
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that you can take all throughout your day to continue practicing. If you liked the video, make sure to like it and leave a comment
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I hope this was helpful and I will see you in the next video
#Tax Preparation & Planning