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Accumulated Earnings Tax (Portfolio 796)

Tax Management Portfolio, Accumulated Earnings Tax, No. 796-3rd, analyzes in detail the problems associated with a corporation's failure to distribute its earnings and profits with the purpose of avoiding the tax on its shareholders. The Portfolio outlines in detail the statutory framework of the accumulated earnings tax, the factors used to determine whether a corporation has a tax avoidance purpose, and a discussion of what constitutes the “reasonable needs” of a business.

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DESCRIPTION

Tax Management Portfolio, Accumulated Earnings Tax, No. 796-3rd, analyzes in detail the problems associated with a corporation's failure to distribute its earnings and profits with the purpose of avoiding the tax on its shareholders. The Portfolio outlines in detail the statutory framework of the accumulated earnings tax, the factors used to determine whether a corporation has a tax avoidance purpose, and a discussion of what constitutes the “reasonable needs” of a business.
The Worksheets include a withdrawn excerpt from the Internal Revenue Manual concerning audit guidelines for Internal Revenue Service agents when they are examining tax returns for the possible application of the accumulated earnings tax. These guidelines were withdrawn in 2000, and have not been reissued. Given that there has been little change, other than rates, in the taxation of accumulated earnings, the guidelines may still be useful in planning and in dealing with examining agents. The Worksheets also contain an illustration of how a corporation could analyze its exposure to the accumulated earnings tax, and a sample taxpayer's statement pursuant to §534(c) and Regs. §1.534-2(d).


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AUTHORS

CAROLINE H. NGO
Caroline H. Ngo, B.S., University of Virginia (2002); J.D., Cornell Law School (2005); Associate, McDermott Will & Emery LLP (2005-present); member, New York and District of Columbia Bars.

JAMES C. WARNER
James C. Warner, B.A., Highest Honors in Business, Grove City College (1971); J.D., Cum Laude, The Ohio State University College of Law (1974); LL.M (Taxation) (1st in class), Georgetown University Law Center (1979); Attorney-advisor, Interpretative Division, IRS Office of Chief Counsel (1974-77); Attorney-advisor, Judge William M. Drennen, U.S. Tax Court (1977-79); Associate and Partner, Lee, Toomey & Kent (1979-93); Adjunct Professor, Georgetown University Law Center (1992-95); President, USA Tax Videos (1994-95); Articles in numerous tax journals (1979-present); Co-Author, 750 T.M., Corporate Overview; Principal and Mergers and Acquisitions Segment Leader, Ernst & Young, LLP's Online Tax Advisor (1996-2004); Senior Director, Tax Research, Wal-Mart Stores, Inc. (2004-08); Tax Research Director, Warner Tax Consulting LLC (2009-present); Author, Practical Guide to Consolidated Returns (CCH 2007); member, District of Columbia and Ohio Bars.

TABLE OF CONTENTS

Detailed Analysis

I. Introduction

II. Rationale & Imposition of Tax

Introductory Material

A. Imposition of the Tax

B. Former § 531 Audit Guidelines

III. Corporations Subject to the § 531 Tax

A. Basic Coverage

B. Parent and Subsidiary Corporations

C. Consolidated Return Group

D. Publicly Held Corporations

E. Foreign Corporations

F. Specifically Excluded Corporations

1. PHCs and Exempt Corporations

2. Corporations in Which Shareholders Are Not Subject to Individual Income Tax

G. S Corporations

IV. Accumulated Taxable Income

A. General Rules

1. Definition and Basic Concepts

a. Tax-Exempt Interest

b. Possession Income

c. Additional Income Allocated Under § 482

d. Exceptions to the § 63 Definition of “Taxable Income”

2. Tax Benefit Rule

3. Short-year Taxable Income

4. Consolidated Accumulated Taxable Income

B. Section 535(b) Adjustments to Taxable Income

1. Taxes

2. Charitable Contributions

3. Special Deductions

4. Net Operating Loss

5. Capital Losses

6. Net Capital Gains

7. Capital Loss Carryover

8. Special Rules for Mere Holding or Investment Companies

9. Special Rules for Capital Gains and Losses of Foreign Corporations

10. Controlled Foreign Corporations

11. Other Special Consolidation Considerations

a. Built-in Deductions

b. Consolidated Earnings and Profits

C. Section 535(c) Accumulated Earnings Credit (Deduction)

1. Minimum Credit

2. Mere Holding or Investment Company

3. Controlled Group of Corporations

4. Consolidated Accumulated Earnings Credit

D. Section 561 Dividends Paid Deduction

1. Dividends Paid Deduction

2. Dividends Paid or Deemed Paid

3. Consent Dividends

4. Consolidated Dividends Paid Deduction

a. Dividends and Consent Dividends

b. Exception for Personal Holding Companies

c. Consolidated Dividends Received Deduction and Consolidated § 247 Deduction

V. Tax Avoidance Purpose

Introductory Material

A. Purpose to Avoid Tax on Shareholders

B. Nature of the Purpose

C. Factors Indicating Tax Avoidance Purpose

1. Reasonableness of Accumulations

2. Holding or Investment Company Status

3. Dividends

4. Loans to Stockholder

5. Tax Rate of Shareholders

6. Low Shareholder-Employee Compensation

7. Unrelated Investments

8. Additional Factors

VI. Burden of Proof

A. General Rule

B. Presumption and Prima Facie Evidence

1. In General

2. Mere Holding or Investment Company

C. Shift of Burden in Tax Court

1. Notification by the IRS

2. Taxpayer's Statement Regarding Accumulations

VII. Reasonable Needs of the Business

Introductory Material

A. Aspects of “Business”

1. Scope

2. Activity

B. Reasonably Anticipated Needs

1. Acquisition or Replacement of Property, Plant, and Equipment

2. Acquisition of, or Expansion into, Other Businesses

3. Working Capital

4. Business Contingencies

5. Taxes

6. Long-Term Debt

7. Stock Redemptions

a. IRS's Position

b. Future Redemptions

c. Past Redemptions

8. Product Liability Loss Reserves

C. Section 303 Redemption Needs

1. Present Law

2. Pre-1969 Case Law

D. Excess Business Holdings Redemption Needs

VIII. Detailed Analysis of Working Capital Needs

Introductory Material

A. Definition of the Term “Working Capital”

1. Current Assets

2. Current Liabilities

B. Operating Cycle

1. The Bardahl Formula - Generally

2. Understanding the Bardahl Calculation: Key Concepts

a. Peak Versus Average Cycle

b. Costs of Operation

c. Credit Cycle

3. Difficulties with the Bardahl Calculation

a. Inventory Problems

b. Accounts Receivable Problems

4. Expansion-Inflation Factor

5. Service Businesses

C. Other Formulae and Rules of Thumb

1. Apollo Industries Formula

2. Rules of Thumb

D. Expert Testimony

IX. Miscellaneous

A. Interest and Negligence Penalty on § 531 Deficiency

B. Information Statement


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 AICPA Professional Standards, Accounting Research Bulletin 43

Worksheet 2 Illustration of Analysis of Corporate Data

Worksheet 3 Taxpayer's Statement Pursuant to § 534(c) and Regs. § 1.534-2(d)

Worksheet 4 Excerpt from Former Internal Revenue Manual, Handbook 4233 - Tax Audit Guidelines; Audit Techniques - Accumulated Earnings Tax [Ch. 600 and Exhibits]

Bibliography

OFFICIAL

Statutes:

Treasury Regulations:

Committee Reports:

Public Laws:

Treasury Rulings:

Cases:

UNOFFICIAL

Periodicals:

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