Question

Explain how the accumulated-earning tax may apply to corporate money set aside to fund a Sec. 303 redemption.

Attach Internal Revenue Code Section

Answer 1

One of the most difficult problems facing a corporation contemplating a possible § 303 redemption concerns the accumulated earnings tax of § 531. In order to take advantage of § 303, a closely held corporation must of course have sufficient funds to finance the redemption. One of the easiest methods is simply to accumulate the corporation's earnings prior to the time of redemption. The accumulated earnings tax, however, may frustrate any such attempt at tax savings, since it appears in some respects to completely counteract the benefits of § 303. In general, § 531 imposes a penalty tax on a corporation when its accumulated earnings and profits exceed $100,000 and it retains earnings beyond the reasonable needs of its business. This section is specifically designed to impose an extra tax on corporations formed or availed of to avoid an income tax on their shareholders..