(a) In general. Whether a particular ground or grounds for the accumulation of earnings and profits indicate that the earnings and profits have been accumulated for the reasonable needs of the business or beyond such needs is dependent upon the particular circumstances of the case. Listed below in paragraphs (b) and (c) of this section are some of the grounds which may be used as guides under ordinary circumstances.
(b) Reasonable accumulation of earnings and profits. Although the following grounds are not exclusive, one or more of such grounds, if supported by sufficient facts, may indicate that the earnings and profits of a corporation are being accumulated for the reasonable needs of the business provided the general requirements under §§ 1.537-1 and 1.537-3 are satisfied:
(1) To provide for bona fide expansion of business or replacement of plant;
(2) To acquire a business enterprise through purchasing stock or assets;
(3) To provide for the retirement of bona fide indebtedness created in connection with the trade or business, such as the establishment of a sinking fund for the purpose of retiring bonds issued by the corporation in accordance with contract obligations incurred on issue;
(4) To provide necessary working capital for the business, such as, for the procurement of inventories;
(5) To provide for investments or loans to suppliers or customers if necessary in order to maintain the business of the corporation; or
(6) To provide for the payment of reasonably anticipated product liability losses, as defined in section 172(j), §§ 1.172-13(b)(1), and 1.537-1(f).
(c) Unreasonable accumulations of earnings and profits. Although the following purposes are not exclusive, accumulations of earnings and profits to meet any one of such objectives may indicate that the earnings and profits of a corporation are being accumulated beyond the reasonable needs of the business:
(1) Loans to shareholders, or the expenditure of funds of the corporation for the personal benefit of the shareholders;
(2) Loans having no reasonable relation to the conduct of the business made to relatives or friends of shareholders, or to other persons;
(3) Loans to another corporation, the business of which is not that of the taxpayer corporation, if the capital stock of such other corporation is owned, directly or indirectly, by the shareholder or shareholders of the taxpayer corporation and such shareholder or shareholders are in control of both corporations;
(4) Investments in properties, or securities which are unrelated to the activities of the business of the taxpayer corporation; or
(5) Retention of earnings and profits to provide against unrealistic hazards.
[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 8096, 51 FR 30484, Aug. 27, 1986]
Notes of Decisions
John P. Scripps Newspapers v. Comm'r, 44 T.C. 453 (Tax Ct. 1965).
· cites it 6× “537-2 (b) and (c), Income Tax Regs. 8 *467 Whether a corporation has permitted its earnings and profits to accumulate beyond its reasonable needs and whether it was *94 availed of for the purpose of avoiding the income tax with respect to its shareholders are both questions of…”
Proctor v. Comm'r, 42 T.C.M. 725 (Tax Ct. 1981).
· cites it 8× “537-3(a), Income Tax Regs. Cf. section 1.355-1(c), Income Tax Regs.”
Hughes, Inc. v. Comm'r, 90 T.C. 1 (Tax Ct. 1988).
· cites it 6× “The need to retain earnings must be directly connected with the needs of the corporation itself and must be for bona fide business purposes. Sec. 1.537-2(a), Income Tax Regs.”
Atlas Tool Co. v. Comm'r, 70 T.C. 86 (Tax Ct. 1978).
· cites it 4× “The parties each submitted a so-called "Bardahl" computation 23 as evidence of Atlas' normal working capital needs and then joined issue over the treatment of Atlas' letters of credit as an extraordinary working capital need.”
Rutter v. Comm'r, 81 T.C. 937 (Tax Ct. 1983).
· cites it 4× “The need for working capital may constitute a sufficient ground for accumulating earnings and profits. Sec.”
Chaney & Hope, Inc. v. Comm'r, 80 T.C. 263 (Tax Ct. 1983).
· cites it 6× “One of the grounds listed by the regulations as a factor which may indicate that earnings are accumulated for reasonable needs of the business is the need to provide for loans to suppliers or customers, if necessary, in order to maintain the business of the corporation.”
Faber Cement Block Co. v. Comm'r, 50 T.C. 317 (Tax Ct. 1968).
· cites it 2× “537-2(b)(4), Income Tax Regs. While neither of the parties directed their attention at the trial to the *152 question of petitioner's working-capital requirements, we think it obvious that such requirements existed during the taxable years at issue.”
Factories Inv. Corp. v. Comm'r, 39 T.C. 908 (Tax Ct. 1963).
· cites it 4× “, it is provided: (c) Unreasonable accumulations of earnings and profits . Although the following purposes are not exclusive, accumulations of earnings and profits to meet any one of such objectives may indicate that the earnings and profits of a corporation are being…”
Novelart Mfg. Co. v. Comm'r, 52 T.C. 794 (Tax Ct. 1969).
· cites it 4× “9 *118 The regulations further provide that an accumulation for the purpose of acquiring a business enterprise through the purchase of stock or assets, or to make investments or loans to suppliers or customers if necessary to maintain the corporation's business, may constitute…”
Magic Mart, Inc. v. Comm'r, 51 T.C. 775 (Tax Ct. 1969).
· cites it 2× “Thus, for example, if such accumulated earnings and profits of prior years are sufficient for the reasonable needs of the business, then any earnings and profits of the current taxable year which are retained will not be considered to be retained for the reasonable needs of the…”
Bardahl Mfg. Corp. v. Comm'r, 24 T.C.M. 1030 (Tax Ct. 1965).
· cites it 4× “On brief, the respondent contends that the amounts of working capital required by petitioner as of the end of 1956, 1957, 1958, and 1959 to cover its anticipated operating costs were $322,965, $348,180, $396,500, and $435,243, respectively.”
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