The Accumulated Earnings Tax and the Reasonable Needs of the Business: A Proposal
![handle is hein.journals/wmlr12 and id is 36 raw text is: THE ACCUMULATED EARNINGS TAX AND THE
REASONABLE NEEDS OF THE BUSINESS: A PROPOSAL
HOMER L. ELLIoTT
The accumulated earnings tax has been referred to as a penalty on
success itself.' Of all the taxes imposed upon business, this is probably
one of the most unpopular, involving an after the fact verdict on manage-
ment's business judgment. As long as substantial differences exist in
the tax rates imposed upon the corporation on the one hand and upon
the individual on the other, however, there will continue to be a need
for such tax as a barrier to . . . tax avoidance. 2
Presently two tests, one subjective and the other objective, are used
to determine whether the tax will be imposed. The subjective test is
derived from section 532(a) of the Internal Revenue Code of 1954,
which provides that the accumulated earnings tax is to be imposed
if the corporation was formed or availed of to avoid income tax on its
shareholders by permitting earnings and profits to accumulate. In
short, this test is based on the subjective intent of the shareholders in
accumulating earnings and profits. The objective test is derived from
section 533(a) and (c) of the Code. Section 533(a) creates a pre-
sumption that the purpose of avoidance is present if earnings are ac-
cumulated beyond the reasonable needs of the corporation's business.
Section 535(c) provides a credit in computing accumulated taxable
income for such part of the earnings and profits for the taxable year
as are retained for the reasonable needs of the business. 3
The thesis of this discussion is that the subjective test no longer
serves a valid purpose, and should therefore be discarded in favor of
the objective test, one based on whether the accumulation serves the
reasonable needs of the business.
*A.B., 1960, Indiana University; J.D., 1969, College of William and Mary. Member of
the firm: Steptoe and Johnson, Washington, D. C.
1. Lang, Section 531-The Burden of Success, U. So. CAL. 1968 TAx IsT. 279.
2. J. HALL, SmA.u BusmNsS AND THE NOIErRATED INCOME TAx STRucrura: STUDY
PREPARED FOR THE JOINT COMMITTEE ON THE ECONOMIC REPORT, 84th Cong., 1st Sess. 682
(1955).
3. INT. REv. CODE of 1954, § 535 (c).
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The Accumulated Earnings Tax and the Reasonable Needs of the Business: A Proposal
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