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Accumulated Earnings Tax Applies Despite Corporation's Lack of Liquidity

(Parker Tax Publishing January 2017)

According to the Office of Chief Counsel, a corporation was subject to the Code Sec. 531 accumulated earnings tax despite a lack of liquidity to make distributions. As the Chief Counsel's Office noted, the tax is based on accumulated taxable income, and at least with respect to a mere holding company for which reasonable business needs are not relevant, is not concerned with the corporation's liquid assets. CCA 201653017.


An individual incorporated a corporation and was the sole owner at all relevant times. Since its inception and during the years at issue, the corporation conducted no business activity other than holding and maintaining various partnership interests contributed to it by its sole shareholder. According to a representative for the corporation, the sole shareholder contributed his partnership interests to the corporation to avoid potential taxation by various tax jurisdictions, such as the state where one of the partnerships is located and the country where the sole shareholder lives. The corporation had no employees and paid no wages or expenses, other than a minimal amount for taxes and accounting and other fees. Each of the partnership agreements contained a provision allowing the partnership to make distributions sufficient to pay the partner's federal and state tax liability, but the remainder of a partner's distributive share of the partnership income was retained in the partnership. Accordingly, the corporation reported its share of distributive partnership income but only received distributions sufficient to pay its tax liability. The corporation, which reported retained earnings each year, neither declared dividends nor made any other distributions to the shareholder during the years at issue. The IRS Office of Chief Counsel was consulted as to whether the corporation could avoid the accumulated earnings tax because it lacked liquidity from which to make distributions to its sole shareholder.

The corporation did not provide justification for the accumulation of earnings, and the board of director minutes for the years at issue did not contain or provide plans for using the accumulated earnings. Instead, the corporation contended that it was not liable for the tax because it did not have control over distributions from the partnerships. Specifically, it argued that since its taxable income was derived solely from the partnerships, and since it could not control what distributions it received, it did not have liquid capital from which to distribute earnings to its shareholder and, thus, should not be subject to the tax.


Code Sec. 531 imposes a tax, equal to 20 percent of a corporation's accumulated taxable income, on every corporation (other than personal holding companies and other companies described in Code Sec. 532(b)) formed or used for the purpose of avoiding the income tax with respect to its shareholders or the shareholders of any other corporation, by permitting earnings and profits to accumulate instead of being divided or distributed. Under Code Sec. 533, a corporation that is a "mere holding company or investment company" is presumed to accumulate earnings to avoid income tax on shareholders. Any corporation other than a mere holding company or investment company is treated as accumulating earnings to avoid income tax only if it accumulates earnings beyond the reasonable needs of the business.

Reg. Sec. 1.533-1(c) defines a "holding company" as a corporation having practically no activities except holding property and collecting the income therefrom or investing therein. Here, the corporation had no activity other than holding and maintaining the various partnership interests transferred to it by its shareholder. Furthermore, none of the partnerships appeared to perform any activity other than investment activity. Accordingly, the Chief Counsel's Office found that the corporation was a mere holding or investment company, which is prima facie evidence that it was formed to avoid tax.

The corporation suggested that accumulated surplus must be represented by cash available for distribution. However, the Chief Counsel's Office noted that the accumulated earnings tax is based on accumulated taxable income and, at least with respect to a mere holding company for which reasonable needs are not relevant, is not concerned with the corporation's liquid assets.

Moreover, the Chief Counsel's Office said, the corporation could have declared consent dividends (which are treated as a distribution of money) to avoid the accumulated earnings tax, irrespective of the lack of liquidity. The Chief Counsel's Office cited TAM 9124001 for the proposition that consent dividends under Code Sec. 565 provide a mechanism to avoid the accumulated earnings tax when there is limited or no ability of a corporation to make distributions. Because consent dividends were not declared in TAM 9124001, the distributive share of a corporation's partnership income was taken into account in determining whether the accumulated earnings tax should be imposed.

In CCA 201653017, the Office of Chief Counsel stated that Congress intended to treat companies declaring consent dividends as if they had made distributions even though they lack the ability to actually do so. Because the corporation was a mere holding or investment company that accumulated earnings and profits, and because consent dividends could have been used to avoid (or at least reduce) the tax but were not used, the Chief Counsel's Office concluded that the corporation remained subject to the accumulated earnings tax in spite of its lack of liquidity and lack of control over the partnerships in which it invested.

For a discussion of the accumulated earnings tax, see Parker Tax ¶42,510.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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