Masonry Magazine March 1978 Page. 21
What's "Reasonable"?
Only IRS Knows
Have you ever wondered how IRS agents determine what makes accumulations of earnings "unreasonable?" It might be worthwhile to take a look at some of the things they take into consideration, since there is a penalty imposed for "unreasonable accumulations," and the key phrase "reasonable needs" to determine what a business requires, is decided individually in each case.
Here are the factors the examiners will take into account towards assessing a penalty:
If the business need for the accumulation is defined in vague and indefinite terms.
If current volume of operations generates sufficient dollar flow to meet the need for working capital.
If investments are of a passive nature, not in liquid form.
If there is only contemplation of diversification into an unrelated business.
If the stock of the corporation is closely held.
If there are stock redemptions.
If loans to shareholders or their other business give an indication of excess accumulations.
If the company has an unfavorable dividend history.
If there is an inability to pay dividends, either because of restrictions on dividend payments or because of a lack of liquid funds.
If there are investments in subsidiaries that are not controlled.
If there are no outstanding debt obligations or incurred for non-business reasons.
If shareholders are in high tax brackets.
If there is a high current asset-current liability ratio.
If there is a high current asset-current working capital ratio.
And, if the corporation is aware of the accumulated earnings tax and has made a conscious effort to avoid its application.
On the opposite side of the ledger are those factors which will work against the assessment of the penalty. These include:
A history of paying good dividends.
Substantial salaries paid to principal stockholder-employees.
If the stock is publicly held rather than owned by a small group.
If there is existence of business indebtedness.
If there is a real need to diversify, as a result of either a one-customer business or a high business obsolescene factor.
If there is documentation of business needs in the corporate minutes, and in performing actual work in fulfilling the needs.
If there is a low current-asset liability ratio.
If there is a low current-asset working capital ratio.
If there is a need demonstrated for more plant and equipment.
AND if there has been an actual entry into an unrelated business.
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MASONRY/MARCH, 1978 21