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Westover Health Services, Inc., a personal service corporation, has two shareholders. Westover was incorporated in 1988; and, has made irregular and infrequent distributions to its shareholders. The balance sheet of Westover Health Services, Inc. reflects unappropriated retained earnings in the amount of $800,000 and no marketable securities. Westover has no specific, definite, and feasible plans for use of the earnings accumulation in its business. It has been determined that the amount needed to redeem a deceased shareholder's stock is $500,000. What is the amount of Accumulated Earnings Tax that Westover Health Services, Inc. could be subject to for tax year ended December 31, 2003?
a. $7,500
b. $45,000
c. $22,500
d.$0
Solution: The correct choice is "b."
In addition to the regular income tax, the IRS may assess a section 531 penalty tax, referred to as the "accumulated earnings tax," against any corporation that accumulates earnings (1) beyond the reasonable needs of the business, and (2) with the intent of having its shareholders avoid the "double taxation" applicable to corporate dividends.
Clearly, to avoid being subject to the accumulated earnings tax, the corporation must demonstrate a reasonable business need...