Example 1. The X Corporation, which is not a mere holding or investment company, has accumulated earnings and profits in the amount of $125,000 as of December 31, 1974. Thus, the minimum credit provided by section 535(c)(2) exceeds the accumulated earnings and profits of X by $25,000. It has earnings and profits for the taxable year ended December 31, 1975, in the amount of $100,000 and has a dividends paid deduction under section 561 in the amount of $30,000 so that the earnings and profits for the taxable year which are retained in the business amount to $70,000. Assume that it has been determined that the earnings and profits for the taxable year which may be retained for the reasonable needs of the business amount to $55,000 and that a deduction has been allowed under section 535(b)(6) in the amount of $5,000. Since the amount by which $150,000 exceeds the accumulated earnings and profits at the close of the preceding taxable year is less than $50,000 ($55,000-$5,000), the minimum credit provided by section 535(c)(2) will not apply and the accumulated earnings credit must be computed under section 535(c)(1) on the basis of the reasonable needs of the business. In this case, the accumulated earnings credit for the taxable year ended December 31, 1975, will be $50,000 computed as follows:
Earnings and profits of the taxable year determined to be retained for the reasonable needs of the business | $55,000 |
Less: The deduction for long-term capital gains (less applicable tax) allowed under sec. 535(b)(6) | 5,000 |
Accumulated earnings credit allowable under sec. 535(c)(1) | 50,000 |
Example 2. The Z Corporation which is not a mere holding or investment company, has accumulated earnings and profits in the amount of $45,000 as of December 31, 1974; it has earnings and profits for the taxable year ended December 31, 1975, in the amount of $115,000 and has a dividends paid deduction under section 561 in the amount of $10,000, so that the earnings and profits for the taxable year which are retained amount to $105,000. Assume that it has been determined that the accumulated earnings and profits of the taxable year which may be retained for the reasonable needs of the business amount to $20,000 and that no deduction is allowable for long-term capital gains under section 535(b)(6). The accumulated earnings credit allowable under section 535(c)(1) on the basis of the reasonable needs of the business is determined to be only $20,000. However, since the amount by which $150,000 exceeds the accumulated earnings and profits at the close of the preceding taxable year is more than $20,000, the minimum accumulated earnings credit provided by section 535(c)(2) is applicable. The allowable credit will be the amount by which $150,000 exceeds the accumulated earnings and profits at the close of the preceding taxable year (i.e., $105,000, $150,000 less $45,000 of accumulated earnings and profits at the close of the preceding taxable year).
26 C.F.R. §1.535-3
Sec. 1561(a) (83 Stat. 599; 26 U.S.C. 1561(a)