PHC Tax and Sec. 382

The personal holding company (PHC) tax is a punitive tax imposed on certain closely held corporations that retain excess PHC income. In calculating the tax, a corporation is afforded a deduction against its PHC income for a net operating loss (NOL) incurred in the preceding tax year. Sec. 382 limits the ability of taxpayers to "traffic" in NOL deductions by limiting the deductibility of a carryforward amount in any period after the loss corporation undergoes a defined ownership change. The question arises as to whether Sec. 382 would also limit the ability to use a PHC deduction for the prior-year loss.

Sec. 545(b)(4) provides that, in computing undistributed PHC income (UPHCI) for any year, the NOL deduction provided in Sec. 172 shall not be allowed, but there shall be allowed as a deduction the NOL (as defined in Sec. 172(c)) for the preceding tax year, completed without reference to the dividend-received deductions. Sec. 382(a) limits the corporation's ability to reduce its taxable income by pre-change losses. Sec. 382(d) defines pre-change losses as any NOL carryforward and any NOL incurred in the year prior to the change. Accordingly, it would appear that, under Sec. 545(b)(4), the NOL of the preceding year (as contrasted with the NOL carryforward or NOL of the current year) can reduce UPHCI, unlimited by the restrictions on the use of NOLs under Sec. 382. In addition to the fact that the loss deduction under the PHC rules does not appear to fit within the definition of pre-change losses under Sec. 382, Sec. 382(a) appears to limit its application only to the calculation of "taxable income" of the loss corporation. The PHC tax is not imposed on the corporation's taxable income, but rather on a modified form of taxable income. Further, for PHC tax purposes, the NOL for the prior year is allowed as a deduction, even though, for the purpose of the "regular" corporate income tax, the prior-year loss was carried back to the two tax years preceding the loss year and fully used as an NOL deduction in those years.

What happens if there is a Sec. 382 ownership change? If the change occurs at the end of the prior year and the corporation has a loss for that year that was carried forward to the succeeding year (for which the UPHCI is being computed), there could be a serious limitation under Sec. 382 on the use of the NOL for Sec. 11 purposes. However, it appears that Sec. 382 operates to limit only the NOL deduction used to compute regular taxable income for Sec. 11 purposes, and does not limit the deduction allowable under Sec. 545(b)(4) in arriving at the UPHCI. Sec. 382 can result in a significant increase in Sec. 11 tax, substantially in excess of the tax under Sec. 541. Practitioners should always keep Sec. 382 in mind, but should be careful not to apply it to the computation of UPHCI, to which it does not apply.

From Paul Farber, CPA, Richard A. Eisner & Company, LLP, New York, NY