USA Law and Practice Contributed by: Devon M Bodoh, Joseph M. Pari and Blake D. Bitter, Weil, Gotshal & Manges LLP
see 1.1 Corporate Forms and Their Tax Treatment and 1.2 Use and Taxation of Transparent Business Structures ) are for the most part regarded as entirely separate legal entities and, as such, are subject to tax on their income; and shareholders are considered to receive income fully subject to tax when they receive distributions from corporations that are out of cor - porate earnings and profits (E&P). Thus, in the USA, corporate income is taxed twice, once at the entity level and again at the shareholder level when earn - ings are distributed; as a result, such system gener - ally prevents individuals from earning income at solely corporate rates. As discussed in 1.1 Corporate Forms and Their Tax Treatment and 1.2 Use and Taxation of Transpar- ent Business Structures , certain types of corporate entities (ie, S corporations, REITs and RICs) provide a mechanism of avoiding corporate-level tax where various requirements are satisfied. 3.3 Restrictions on Retention of Earnings by Closely Held Corporations The retention of profits may trigger additional tax lia - bility, such as the accumulated earnings tax (AET) (ie, a 20% penalty tax) imposed on corporations formed or availed for the purpose of avoiding the income tax with respect to their shareholders, or the personal holding company (PHC) tax (ie, a 20% tax on undis - tributed PHC income) imposed on corporations that mainly derive passive-category income and the major - ity of which is owned by five or fewer individuals. Notably, the PHC tax contrasts with the AET in several respects. First, if the requirements of the PHC tax are met, it applies automatically – there is no “intent” ele - ment that the government must establish. Second, if the PHC tax applies, the corporation must self-assess the tax by making certain filings with its annual tax return – failure to do so may subject it to additional penalties (ie, the AET is imposed by the IRS upon audit). 3.4 Taxation of Individuals on Shares in Closely Held Corporations For US individuals, gains from the disposition of capi - tal assets (ie, shares) held for more than one year (ie, long-term capital gains) are subject to preferential
capital gains tax rates – losses from the disposition of capital assets may offset capital gains and, if they exceed such gains, ordinary income up to USD3,000 per year. Any unused capital losses can be carried forward indefinitely. Gain from the sale of shares may also be subject to a 3.8% net investment income tax for certain taxpayers whose income exceeds certain thresholds (generally USD200,000-250,000). Distributions by a corporation to individual share - holders are taxed as “dividends” only to the extent that they are paid out of the corporation’s current or accumulated E&P. Dividends received from domestic and certain qualifying foreign corporations received by individual shareholders (Qualified Dividends) may be taxed at a preferential tax rate or, if not Qualified Dividends, then at regular individual tax rates. If the corporation has no E&P (or if the distribution exceeds the corporation’s E&P), the individual shareholder will be allowed to treat the distribution (or the excess, in the latter case) as a return of capital, to the extent of the shareholder’s basis in the stock. Any distribution in excess of basis will be treated as gain from the sale of stock. US-sourced dividend income generally constitutes fixed or determinable annual or periodic gains, profits and income (collectively referred to as FDAP) (see 4.1 Application of Withholding Taxes ) and is subject to a 30% withholding tax if paid to a non-US tax resident, unless reduced by an applicable treaty. Gains from the sale of stock by a non-US tax resident are generally treated as giving rise to foreign-sourced income and, as such, are not subject to US tax. 3.5 Taxation of Individuals on Shares in Public Corporations Individuals (both US residents and non-US residents) are generally subject to the same rules discussed in 3.4 Taxation of Individuals on Shares in Closely Held Corporations with respect to dividends from, and gain on, shares in publicly traded corporations.
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