What is a Personal Holding Company and How to Use One for Passive Investment Income
What is a personal holding company
A personal holding company is a type of business structure that is owned and controlled by an individual or a small group of individuals. It is often used to hold and manage passive investments, such as stocks, bonds, and real estate, and to provide tax benefits to its shareholders.
Under the Internal Revenue Service (IRS) rules, a personal holding company is defined as a corporation in which more than 50% of the stock is owned by or for the benefit of five or fewer individuals, at least 60% of its gross income is personal holding company income, and its business is not predominantly active.
Personal holding company income is defined as passive investment income, such as dividends, interest, and rent. It does not include income from active trading or business activities.
One of the main tax benefits of a personal holding company is that it allows shareholders to take advantage of lower tax rates on passive investment income. Ordinarily, passive income is taxed at the individual tax rate, which can be as high as 37%. However, if that income is earned through a personal holding company, it may be taxed at a lower corporate tax rate, which is currently 21%.
How can I use a personal holding company to save on my taxes
So how do you use a personal holding company to manage your passive investments and take advantage of these tax benefits? Here are some steps to consider:
Incorporate your personal holding company: To set up a personal holding company, you will need to incorporate it as a separate legal entity. This can typically be done through your state's Secretary of State office.
Transfer your passive investments to the personal holding company: Once your personal holding company is set up, you can transfer your passive investments, such as stocks and real estate, into the company's ownership. This can be done through a process called asset transfer.
Elect S corporation tax treatment: By electing to be taxed as an S corporation, your personal holding company can avoid the double taxation that typically applies to C corporations. This can be done by filing Form 2553 with the IRS.
Follow compliance and reporting requirements: Personal holding companies are subject to certain compliance and reporting requirements, such as filing annual tax returns and holding shareholder meetings. It's important to be aware of and meet these requirements to avoid any potential penalties.
It's worth noting that personal holding companies are subject to a special tax called the personal holding company tax, which is designed to prevent individuals from using a corporation to avoid paying higher individual tax rates. However, as long as your personal holding company meets the IRS requirements and follows the proper procedures, it can be a useful tool for managing passive investments and minimizing your tax liability.