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Earnings accumulation tax assessed against Able and Baker

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Williams Queen owns all the stock in Able and Baker Corporations. Able, a successful enterprise, has generated excess working capital of $3 million. Baker is still in its developmental stages and has had substantial capital needs. To meet some of these needs, Williams had Able lend baker $2 million during 2008 and 2009. These loans are secured by Baker notes, but no other Baker property. Able has charged Baker interest at a rate ordinarily charged by a commercial lender.

Upon reviewing Able's 2010 books in the audit of its 2008 tax return, and IRS agent indicates that Able is liable for accumulated earnings tax because of its build up to excess working capital and its loans to Baker. Later this week, you will meet with the agent for a third time. Before this meeting you will need to know whether loans to a related corporation to finance its working capital meet a reasonable need of the business.

At a meeting to discuss this problem, William asks whether filing a consolidated tax return would eliminate this potential problem and if so, how must the ownership structure change to accomplish this objective?

Sources:
IRC Secs. 532 and 537
Reg. Secs. 1.537-2 and -3(b) and 1.1502-43
Latchis Theatres of Keene, Inc. v. CIR, 45 AFTR 1936, 54-2 USTC ¶9544 (1st Cir., 1954)
Bremerton Sun Publishing Co., 44T.C. 566 (1965)

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Solution Summary

Earnings accumulation tax assessed against Able and Baker is examined.

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The loan to a related corporation to finance its working capital does not meet a reasonable need of the business, in Reg. Sec. 1.537-2(a), (b), and (c) explains what ground or grounds for the accumulation of earnings and profits demonstrate the earnings and profits have been accumulated for the reasonable needs of the business or beyond such needs of the business dependent of the case. 1.537-2(c) (3) explains the particular grounds ...

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