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Accumulated Earnings
1. I.R.C. §§ 531 through 537 govern the imposition of a
surtax on corporations deemed to have engaged in unreasonable
(i.e., excessive) accumulations of earnings and profits for
purposes including the insulation of shareholders against income
taxes which they would have had to pay if the corporations had
paid out (more of) their incomes in dividends. Taxpayers against
whom the accumulated earnings tax is asserted have-as is common
to liabilities imposed under subtitle A of the Code-two
alternative (and mutually exclusive) remedies: redetermination
(prior to any payment) of liability by the Tax Court; or refund
suit (following payment) in either the Claims Court or the
appropriate U.S. district court.
2. I.R.C. § 531 imposes the tax. I.R.C. § 532 defines the
corporations to which the tax applies. I.R.C. § 533 amplifies
I.R.C. § 532 and generally puts the burden of proof concerning
the absence of the proscribed purpose on the corporations if
their accumulations exceed their reasonable needs.
3. I.R.C. § 534 is for purposes of both these instructions
and Tax Court cases the most significant of the statutory
provisions dealing with the accumulated earnings tax. It
allows-in cases before the Tax Court, only-the taxpayer, in
certain circumstances, to shift to the Commissioner the burden of
proving accumulation beyond the reasonable needs of the business.
4. I.R.C. § 535 defines "accumulated taxable
income." I.R.C. § 536 is a technical pronouncement not
immediately pertinent here. I.R.C. § 537 provides that
"reasonable needs of the business" include
"reasonably anticipated" needs. All such reasonable
needs, present or prospective, are necessarily needs for the use
of capital.
5. Capital can be used either on a long term basis, i.e. ,
buildings, machinery and equipment or, short term, to provide
money for operating expenses during recurrent
expenditures--receipt cycles, as for example, a Christmas tree
ornament manufacturing concern which may make its products during
the first two quarters of every year, ship them to customers in
the third quarter and receive the bulk of its cash flow in the
fourth quarter.
A. Accumulations of earnings for long term purposes ordinarily
qualify as reasonable only if supported by the prior
establishment of a definite and feasible plan for their use for a
specific (capital) purpose within a realistic period.
B. Retentions of earnings for use as operating capital through
the course of a disbursement--receipt business cycle are viewed
as held for reasonable business needs only to the extent
established by a version or variation of the "Bardahl
Formula."
6. Significantly, the I.R.C. § 531 issue comprises one
instance in which a taxpayer obtains a tactical advantage by
choosing the Tax Court as the forum for relief. By complying with
the provisions of I.R.C. § 534 the taxpayer may shift to the
Commissioner the burden of proving whether earnings and profits
have been allowed to accumulate beyond the reasonable needs of
the taxpayer's business. An amount equal to whatever amount of
the current earnings that are retained for the reasonable needs
of the business is allowed under I.R.C. § 535(c) as a part of
the accumulated earnings credit in the computation of the
accumulated taxable income subject to the additional tax. In view
of the interrelationship of the allowance of such accumulated
earnings credit, a determination as to reasonable business needs
is implicit in the computations. Therefore determination of the
reasonable needs of the business is pertinent both as an
evidentiary matter which may be determinative of the proscribed
purpose and in the computation of any accumulated earnings
subject to tax.
7. In defending accumulated earnings tax cases, in whatever
court, the Government is not under any requirement or duty to
allege or prove the amount of tax "saved" by any
stockholder in consequence of the purported unreasonable
accumulation of corporate earnings. However, in any given case,
the trial attorney may adopt that tactic to strengthen the
Government's position. A stockholder's return can be used as
evidence. However, even though disclosure of the returns is
permissible for that purpose, it is preferable to limit
disclosure as much as possible and proceed through stipulation
whenever feasible.
Statutory Procedures in Tax Court Cases Concerning Burden
of Proof as to Reasonable Business Needs
1. I.R.C. § 534 provides that the burden of proof in the Tax
Court with respect to an allegation that all or any part of
earnings and profits have been permitted to accumulate beyond the
reasonable needs of the business shall: If a notification with
respect thereto has not been timely sent, be on the Commissioner;
or-If a statement has been timely submitted by the taxpayer in
response to such notification, be on the Commissioner with
respect to those grounds set forth in such statement in
accordance with the statutory provisions. Any determination
imposing the accumulated earnings tax is necessarily based on
some sort of allegation that earnings have been accumulated
beyond the reasonable needs of the business inasmuch as the
interrelationship of the accumulated earnings credit, including
an allowance for current earnings retained for the reasonable
needs of the business, would otherwise eliminate the accumulated
taxable income.
2. I.R.C. § 534 has no effect with respect to the burden of
proof as to the ultimate test of whether the corporation was
formed or availed of for the prohibited purpose.
3. In order to avoid or to limit the burden of proof with
respect to the reasonable needs of the business, the Service must
timely send by registered or certified mail a notification
informing the taxpayer that a proposed assertion of tax or
addition to tax includes imposition of the accumulated earnings
tax. To be timely, such notification must be sent prior to the
issuance of the 90-day letter.
4. If a timely notification has been sent, the taxpayer must
timely submit a valid statement in response thereto in order to
shift to the Commissioner the burden of proof as to the grounds
(supported by facts to show the basis thereof) set forth in such
statement to establish that earnings were not accumulated beyond
the reasonable needs of the business. To be timely, taxpayer's
statement must be submitted within 60 days (with a 30-day
extension available) after the mailing of the notification. To be
properly submitted the statement must be sent to the Internal
Revenue Service office which issued the notification of the
proposed assertion of the accumulated earnings tax.
5. If the taxpayer has submitted to the Commissioner a statement purported to satisfy the requirements of I.R.C. § 534(c), the Tax Court will ordinarily, on timely motion filed after the case has been calendared for trial, rule prior to the trial on whether such statement is sufficient to shift the burden of proof to the Commissioner to the limited extent set forth in I.R.C. § 534(a)(2). See T.C. Rule 142(e).
