Revenue Ruling 84-31 and Personal Holding Company Income

An Internal Revenue Service (IRS) Revenue Ruling is an official interpretation of tax law that provides guidance on how the agency will treat a particular transaction. For professionals in the entertainment industry who provide their services through a corporate entity, Revenue Ruling 84-31 is important guidance. It clarifies the tax treatment of certain payments received by these corporations, often called “loan-out” corporations, addressing a concern that could otherwise lead to significant penalty taxes.

Understanding Personal Holding Companies and Their Tax Implications

The personal holding company (PHC) rules were established to prevent individuals from avoiding higher individual income tax rates by sheltering certain income within a corporation. A corporation that primarily holds investments generating passive income, rather than running an active business, could be subject to these rules. The first IRS test to determine if a corporation is a PHC is a stock ownership test. This is met if more than 50% of the corporation’s stock value is owned by five or fewer individuals during the last half of the tax year.

The second is an income test, met if at least 60% of the corporation’s “adjusted ordinary gross income” is “personal holding company income.” This category includes passive sources like dividends, interest, and royalties, as well as income from certain personal service contracts. If a corporation meets both tests, it is classified as a PHC and faces a 20% penalty tax on its undistributed PHC income.

The Core Conclusion of Revenue Ruling 84-31

Revenue Ruling 84-31 addresses how certain payments in the entertainment industry fit within the PHC framework. The ruling examines a scenario where a corporation contracts with a motion picture producer for an entertainer’s services. A separate collective bargaining agreement requires the producer to make additional payments, known as residuals, to a guild when the motion picture is later broadcast. The guild then forwards these payments to the entertainer’s corporation.

The central question was whether these residual payments constituted PHC income, specifically royalties. The IRS concluded that these payments are not personal holding company income. The reasoning is that the character of the income is determined by its origin. Since the payments stem from the original services provided by the entertainer, they are considered compensation for services rendered, not royalties for the use of property.

Conditions for Applying the Ruling’s Favorable Treatment

To benefit from the treatment in Revenue Ruling 84-31, a specific set of circumstances must be in place. The structure of the agreements is a requirement. There must be a three-party arrangement involving the producer, the performer’s personal service corporation, and a professional guild that acts as a collection and distribution agent. The payments must be for the reuse or rebroadcast of the original work created under the service agreement.

The role of the guild is another condition. The guild must act as a conduit, collecting the residual payments from the producer and then remitting them to the performer’s corporation. This structure reinforces that the payments are linked to the collective bargaining agreement and the original employment contract. Corporations must ensure their contractual arrangements mirror the facts in the ruling to exclude these payments from their PHC income calculation.

Corporate Tax Return Reporting

When a corporation’s residual income qualifies for the treatment in Revenue Ruling 84-31, the reporting on its corporate income tax return, Form 1120, is straightforward. This income should be reported as part of the corporation’s ordinary gross income from its business operations, not as passive or royalty income. This classification is for the PHC calculation performed on Schedule PH (Form 1120), U.S. Personal Holding Company (PHC) Tax.

By treating this income as compensation for services, it is excluded from the numerator of the PHC income test. This significantly reduces the chances of the corporation meeting the 60% income threshold, even if it meets the stock ownership test. Consequently, the corporation can often avoid the PHC designation and the associated penalty tax on undistributed income.