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

Answer:

Omar's ability to achieve tax savings by shifting income to a corporation may be limited by accumulated earnings tax (AET) or personal holding company (PHC) taxes. Omar could be subject to a 20% penalty tax on undistributed income retained by the corporation.

Explanation:

Omar is not the first genius to try to cheat on the IRS by setting up corporations in order to avoid income taxes. Section 531 of the Internal Revenue Code sets a 20% penalty on corporations that do not distribute earnings. The retained earnings threshold is set at $250,000 for C corporations and $150,000 for personal service corporations.

Also, if Omar is going to be the sole owner of the corporation, he will have to pay 20% personal holding company taxes. Any corporation where 5 or less shareholders owe more than 50% of the stocks is considered a personal holding company.