In determining whether current earnings were accumulated for reasonable business purposes, the examiner must make a determination of whether prior accumulations were, in fact, sufficient to meet the taxpayer's current needs. In making this determination, it is necessary to examine the character of the corporation's assets, since earnings used for the expansion of business plant or equipment, inventories, or accounts receivable cannot be readily distributed to the stockholders no matter how large the corporation's earned surplus may be.

This issue requires a thorough analysis of the corporation's business and financial status for each year, including:

The term "reasonable needs of the business" includes the reasonably anticipated needs of the business.

The following items, while not exclusive, may indicate that the earnings and profits are being accumulated for the reasonable needs of the business and should be used as guides:

Apart from the grounds specifically mentioned above, accumulations may be justified by a range of business needs. Among these are the following:

Accumulations have been justified as a result of various forms of contingencies including the following:

A corporation cannot be required to resort to the borrowing of funds under any circumstances. Therefore, the current operations of the business or planned expansion may be financed fully by retained earnings.

An accumulation to retire a corporate indebtedness has in most cases been determined to be a reasonable need of the business, depending upon the reason the debt was created in the first place.

The examiner should determine if the debt to be retired by the accumulation was bona fide and was incurred in connection with the trade or business.

Events subsequent to the end of the taxable year may not be used to show that retention of earnings and profits was unreasonable at the close of such taxable year if all the events indicated a reasonable accumulation at the close of the taxable year.

Examiners may consider subsequent events to determine the taxpayer actually intended to carry out or has actually carried out the plans for which the earnings and profits were accumulated. The fact that the corporation did not, in fact, use the accumulated funds as originally planned does not necessarily mean that the accumulation was not reasonable when made. However, if the earnings are not used to accomplish the purpose for which they were to be used, this may indicate that the earnings were not to be used for the indicated purpose in the first place and will make any future accumulations more difficult to justify.

The working capital needs of a business are justification of accumulating earnings and profits.

Inasmuch as the need for working capital has long been recognized as the main reason for accumulating earnings and profits, the examiner should compute the Bardahl formula as modified by the Empire Steel Casting decision, on a preliminary basis by using the figures shown on the return to calculate reasonable working capital needs. If the taxpayer's net working capital exceeds the calculated reasonable working needs, then further analysis should be made following the procedures set forth in Exhibit 4.10.13-1 and Exhibit 4.10.13-2. See also IRM Exhibit 35.4.24-1.

In an expanding business, the examiner should obtain the necessary financial information to compute the corporation's working capital needs in the years immediately preceding the year or years under examination and the years immediately succeeding the year or years under exam.

For seasonal business, the Bardahl International formula is considered more appropriate for peak inventory and receivable months. For service business, the formulas should be modified to consider the average length of time required to perform on a contract rather than use the operating inventory turnover concept. The Apollo formula may have application to nonmanufacturing businesses. See Exhibit 4.10.13-3.

As noted above, the Bardahl formula is " one test" and is not necessarily applicable to every IRC section 531 case. Examiners who are considering IRC section 531 should analyze each case with respect to specific facts before determining the type of operating cycle approach most appropriate.

The latest criteria relied on in current court decisions should be considered.

In an attempt to collect a tax liability, the Collection function may refer transferee cases to the Examination function for assistance.

Collection prepares Form 3031, Report of Investigation of Transferee Liability, to recommend a transferee assessment. The Advisory Section reviews the report to ensure that pertinent factual data and adequate evidence is obtained to sustain assertion of the transferee liability. Once approved, the original report is forwarded to Planning and Special Procedures (PSP) to establish the transferee case on AIMS non-master file and to forward the case to an examination group.

Examiners are required to consider collectibility in every examination. As such, they must be able to identify situations in which the taxpayer has intentionally or inadvertently placed assets out of the legal reach of the IRS. Additionally, they must be able to identify situations in which asset transfers may not be conducted in a "normal business manner " because of the close relationship of the parties involved.

If the taxpayer gives an indication of insolvency, the examiner should try to learn about the disposition of the taxpayer's assets and/or the transferee's legal responsibility for payment of the transferor's tax liability. The examiner must consider whether the elements of a transferee examination, as described below, have been met.

A transferee case will be initiated once the examiner determines:

Examiners are responsible for the identification and development of potential transferee cases that arise during their examinations. Examiners should not assume that Collection will develop a transferee case after the transferor's examination is concluded. By the time a case is routed to a Revenue Officer (RO) for collection, the transferee statute of limitations may prevent adequate consideration.

Transferee Liability in Equity is the most common form of transferee liability. A Transferee in Equity is a person or entity who receives the transferor's assets for less than full, fair and adequate consideration, leaving the transferor insolvent and unable to pay the tax liability. Transferee in Equity cases are predicated on State or Federal Fraudulent Conveyance Statutes (i.e., 28 U.S.C 3301-3308).

The liability of a transferee in equity is limited to the lesser of the value of the assets received from the transferor, plus possible interest, or the total outstanding tax, penalties and interest owed by the transferor.

The Government must prove the value of the assets transferred. Where the assets transferred are subject to existing liabilities or assumed by the transferee, the value of the property received should be reduced by the associated liability in determining the limit of transferee liability.

It should be noted that the mere fact that the transferee uses assets which he receives to pay debts of the transferor will not relieve him of transferee liability. He/she must also show that the debts paid had priority over the tax liability. A transferee does not cease to be a transferee merely by selling the transferred property. Additionally, the price at which the transferee sells the property is not an accurate measure of the transferee liability. Rather, the liability is measured by the value of the property that was transferred on the date of transfer.

Even though a taxpayer admits that he is a transferee of assets of a dissolved corporation, unless he admits the extent of his liability, the Government must still prove the value of the assets so received in order that the Court can determine the amount due from him.

The five elements that must be proved by the Government to establish transferee liability are:

A transferee at law is a person or entity that is responsible for payment of the transferor's tax liability due to:

In transferee at law situations (i.e., (a), (b), and (c) above) insolvency of the transferor is not an issue. The government is relieved of this burden.

In determining the extent of the transferee's liability at law, the value of the assets received by the transferee is immaterial since the extent of such liability is determined by reference to the amount of tax liability of the transferor that the transferee has agreed to pay (determined by contract or statute). Where transferee liability is based on estoppel, the liability is limited to the value of the assets received. Some state statutes may also limit liability to the value of assets received.

Documentation required for transferees at law must show:

Statutory mergers where the surviving corporation is primarily liable for the debts of the merged corporation do not result in a transferee situation. The resulting surviving corporation is not a transferee, but is liable the same as the prior transferor corporation. Consult the contracts and agreements affecting the merger to see what type of transaction occurred.

If the period of limitations for assessment against a transferee has expired, action against the transferee under the trust fund doctrine for the collection of the unpaid tax assessed against the transferor should be considered. If timely assessments have been made against the transferor and the period for instituting suit for collection provided in IRC section 6502(a) has not expired, but the time for transferee proceeding has expired, the case, accompanied by a report containing facts in support of the transferee's liability, should be forwarded to Area Counsel through Technical Services.

In attempting to collect the transferor's tax liability through a transferee case, the transferor's tax liability should always be assessed or a statutory Notice of Deficiency issued prior to the expiration of the transferor's statute of limitations unless one of the exceptions below has been met:

If a deficiency in tax is determined in the case of the transferor and the statute of limitations has expired, the deficiency should be asserted against the transferee(s) within the period of limitations applicable to him/her.

Although it is unlikely that the Service will be able to collect from the transferor, it is better to proceed against the transferor in the interest of protecting the Government and eliminating a possible defense of the transferees because of two required elements of transferee liability:

Transferee situations are very prevalent with dissolved corporations. If the corporation has been dissolved, there may be no assets against which to collect any proposed assessments. In that event, it may be necessary to utilize transferee liability provisions of IRC section 6901 to collect the corporate liability. A transferee case will be developed concurrently with the corporate examination if the elements needed to establish a transferee case are present. Otherwise, the examiner may consider limiting the scope of the examination. Also see IRM 4.11.52 and IRM 5.17.14.3 for additional information.

Federal law, not state law, sets the statute of limitations on assessment and collection of federal taxes for transferee liability cases. State corporate dissolution law does not shorten the assessment limitations period provided by IRC section 6501. State law may, however, adversely affect the capacity of a dissolved corporation or its last board of directors to represent the dissolved corporation or to act on its behalf. This will affect the corporation's ability to extend the statute of limitations, to agree to tax liabilities or to litigate corporate liabilities.

State corporate dissolution law governs how a corporation may dissolve. The state law may provide a specific time period for a dissolved corporation to wind up its affairs. Some states have a specific period in which to wind up affairs, while others do not. Only the individuals named in the applicable state law are authorized to act for the dissolved corporation and only during the winding up period. Such appointment may divest others (the officers prior to dissolution) of authority to act on behalf of the corporation. A consent must be executed by the authorized officer of a dissolved corporation on or before the last date of the winding up period in order to be valid and to hold the period of limitations open after the end of the winding up period.

Caution should be exercised in obtaining waivers of restriction on assessment and extensions of the statutes of limitations in dissolved corporation and transferee cases. Examiners should not rely on any such agreements without the approval of Area Counsel.

The state law which governs the corporate dissolution is the law of the state in which the corporation was organized. For example, if a corporation has its offices in Florida, does business entirely in Florida, was examined by the IRS in Florida, but was organized under Delaware law, authority to execute a consent should be tested under Delaware law, not Florida law.

Examiners should consult the applicable state corporate dissolution law and identify which individuals (corporate officers, board of directors, etc.) are legally authorized to act for the dissolved corporate entity. Area Counsel may be contacted to request an opinion on who is authorized to act for the corporation.

The examiner will also ensure that the individuals authorized to represent the dissolved corporation have been appointed to these duties by the corporation. Documentation will be obtained to satisfy this requirement and will be attached to any consent or waiver that the authorized individuals sign. A provision should be added below the signatures of the appointed individuals stating their title (i.e., "trustee of X corporation, a dissolved corporation " ). A provision should also be added that the corporation has dissolved, but is continuing as a corporate body under (name the section of state law).

The corporation and it's authorized officers/directors may perform the following acts up to the end of the winding up period:

Precautions that should be taken in obtaining waivers of restriction on assessment and extensions of the statute of limitation in transferee and dissolved corporation cases.

Some state corporate dissolution law provides that the dissolution of a corporation may be revoked within stated periods. If this occurs, this may affect the authority of the corporation or it's directors. Examiners should always inquire if a revocation of dissolution has occurred.

IRC section 6901 is only applicable to income, estate, and gift taxes. Transferee liability procedures are not available to employment, excise, and other types of taxes in the Code unless they are involved in the liquidation of a corporation, partnership, or upon the reorganization of a corporation pursuant to IRC section 368(a). A liquidation is deemed to have occurred if the business entity has ceased to do business and the assets of the entity have been distributed to the owners.

When a corporation is dissolved pursuant to state laws in a merger or consolidation proceeding, the successor corporation is not a transferee. The new or surviving corporation assumes primary liability for the debts of the merged or consolidated corporation. Action to assess the primary liability against the new/surviving corporation should be taken within the statutory period of limitations for assessment against the merged or consolidated corporation. If the period of limitations needs to be extended in order to make this assessment, Form 872 or Form 872-A must be executed by the new/surviving corporation before the expiration of the period of limitations for assessment against the merged or consolidated corporation. The corporate name on Form 872 or Form 872-A will be completed and signed as: " B Corporation, Inc., Successor in interest to A, Inc." .

The examiner should ensure that the successor corporation is solely responsible for the liabilities of the dissolved entity. Many merger and consolidation agreements allocate some or all of the liabilities to other parties, including the sellers, with respect to the dissolved entity. Documents verifying the terms of sale should be scrutinized where possible to resolve any discrepancies.

If the transferee case was received from Collection, the examiner will satisfy his/herself that all of the elements required in a transferee case have been documented by the RO on Form 3031. If the elements required, as outlined earlier, have not been documented, the examiner will contact the transferee (and if needed, the transferor), to interview and obtain additional documentation to support the elements required in the transferee case.

If a transferee case is initiated during the examination of a transferor, the examiner will develop the elements required in a transferee case and obtain documentation to support each of the elements. The transferee will be advised that they are under examination as a transferee. An interview with the transferee may need to be scheduled and conducted in order to develop all elements and to obtain supporting documentation.

The examiner will charge his/her time to activity code 812 - detail to the Collection function.

When all of the elements have been fully developed and documented, the examiner will prepare the following waivers, solicit an agreement and payment from the transferees, and hold a closing conference:

Each transferee should be a separate case file, as it is separate and distinct from the transferor examination. Whenever the transferee's name is written in the file, it should have the title "Transferee" after it to distinguish it from an income tax examination of the same entity.

Form 4665, Report Transmittal, should set forth all necessary facts of a confidential nature. This will include a clear statement of the present ability of the transferor and each transferee to pay, with names, addresses, amounts and nature of property held by each that may be subjected to use in payment of the tax.

Each transferee file will contain a transferee report, which is prepared in memorandum form. The memorandum will be very detailed if the case if unagreed. It will list the name, address, and TIN of the transferee and the transferor. The memorandum will contain the following:

Documentation and workpapers will be attached to the memorandum. If it is voluminous, the workpapers and documentation will be attached to a Form 4318-A, which will be used to index the workpapers.

A Form 5344, Examination Closing Record, will not be completed for the transferee case file.

In cases in which the transferor is a corporation, the examiner will include the following information in the transferee report:

In cases in which the transferor is deceased, the examiner will include the following information in the transferee report:

If the transferee case is unagreed, the examiner will prepare the 30-day letter using Letter 955, modified as necessary.

Special language will be inserted as the opening paragraph to Letter 955, depending on the circumstances of the case.

If the transferee case is agreed, the case will be forwarded to Technical Services for special handling. Technical Services will prepare Form 1296, Assessment Against Transferee or Fiduciary, see IRM 4.8.8, Technical Services, Miscellaneous Responsibilities. Technical Services will also complete Form 10904, Request for Record Deletion from AIMS/ERCS, using disposal code 28 and include the form inside the case file. Technical Services will then forward the case to Case Processing for assessment.

If the transferee examination is within six months of the statute expiration date or if the transferee failed to file a valid protest to the 30-day letter, the transferee case will be forwarded to Technical Services for issuance of a Statutory Notice of Transferee Liability.

At the present time, the transferee's liability for interest has not been clearly established where the value of the transferred assets is less than the original tax liability. The Tax Court stated that where the transferred assets are insufficient to pay the liability, interest is not allowed on the tax liability itself because transferee liability is limited to the amount transferred. However, interest can be charged against the transferee for the use of transferred assets, and since this involves the extent of transferee liability, it is to be determined by state law.

Under this theory, the United States is in much the same position as a private creditor under state law. The transferee is liable for interest only from the date the statutory notice of deficiency is sent to the transferee and he/she becomes aware of the debtor-creditor relationship between him/herself and the United States. This appears to be the prevailing view, especially if constructive fraud is proved. Some jurisdictions hold the transferee liable for interest from a prior date, such as the date of transfer, if there was actual fraud. Many states will not hold the transferee liable for interest prior to the date of notice of his/her liability unless the transferee had actual knowledge of the fraud.

In summary, if the transferee had no knowledge of the fraud, he/she will often be liable for interest from the date he/she received notice. Otherwise, he/she may be liable from an earlier date, such as the fair average date of receiving, or the date of transfer. Contact Area Counsel for the applicable state law.

When closing a transferee case in which the assets transferred are less than the transferor's liability, Form 3198 should be annotated: " Transferee Case - Limited Liability" .

When Letter 950 is sent to transferees, the following opening pattern paragraphs will be used in straight deficiency cases (if employment tax is involved, the words "income tax" will be changed to "employment tax" and "years" will be changed to "periods" .

In mixed deficiency and overassessment cases involving transferee or fiduciary liability, the opening paragraphs inserted in Letter 950 will be suitable revisions of pattern paragraphs P-30 to P-35 as shown above.

If the value of the assets received by a transferee is less than the unpaid tax liability of the transferor, the opening paragraphs P-30 to P-32 will be used, but modified by the following phrase:

The opening paragraph of the statutory notice of transferee liability is dependent upon the circumstances of the case. The language for the various opening paragraphs is contained in IRM 4.14.1.14.4, Statutory Notices of Deficiency.

The attachment to the letter is an explanation to the transferee as to where the proposed assessment originated. The attachment to the letter is divided into two parts:

The attachment to the letter will be prepared in the format, with the language, shown in IRM 4.14.1.14.4, Statutory Notices of Deficiency.

Is an arm's length interest rate charged? If either IRC section 483 or IRC section 7872 applies, it should be used as the primary position. If there is a dispute over whether one of these applies or if it is unclear, IRC section 482 should be raised as an alternative position.

When considering loans between two related entities, the Service is not necessarily bound to the position of "imputing" interest income under IRC section 482. Under certain circumstances, the Service may use section 482 to reallocate interest expense claimed by one entity to its affiliate. In Kahler Corp. V. Commissioner, 486 F.2d 1 (1973), revg. 58 TC 496 (1972), the common parent of an affiliated group borrowed funds from third party lenders. Subsequently, the parent reloaned some of its borrowed funds to two of its subsidiaries interest free. The affiliated group did not file a consolidated return. The parent was in a high tax bracket and thus, received a significant benefit from the interest expense it claimed. On the other hand, both of the two subsidiaries were in much lower tax brackets and would not have derived much benefit.

Similarly, in Latham Park Manor, Inc. v. Commissioner, 69 TC 199 (1977), in his concurrence, Judge Scott stated:

In S. W. Haag, 88 TC 604, a physician assigned his interest in a medical partnership to his professional corporation. Although the doctor provided medical services to the corporation, he received either no salary or minimal salary for the years in question. The court stated, "Petitioner would not have agreed to work for no compensation if he had bargained at arm's length with an uncontrolled entity." and upheld the government's section 482 adjustment, which was "the difference between the amount of compensation petitioner would have received in each year absent of incorporation and the amount he actually received."

In D. F. Keller, 77 TC 1014, in determining the applicability of section 482 to a pathologist's compensation, his total compensation (salary, pension plan contributions, and medical benefits) was compared to what the petitioner would have bargained for in an arm's-length transaction with an unrelated party.

Due to employment tax considerations, it appears when inadequate compensation is paid to a shareholder/employee, consideration should be given to whether loans to the shareholder should be recharacterized as compensation instead of treating them as dividend distributions. It would appear it may be in the government's best interest to raise section 482 as the primary position whenever the C corporation has a net operating loss or does not have sufficient earnings and profit.

In J. J. Haber, 52 TC 255, a S corporation made loans to one of its shareholder/employees over several years but reduced the shareholder/employee's salary by the amount of the loans. The loans were recharacterized as compensation for services. Although raising a section 482 issue on compensation from an S corporation will usually have a wash effect on income tax, it should be considered when the shareholder otherwise has no earnings subject to FICA tax.

The Supreme Court stated in Lucas v. Earl, 281 U.S. 111 (1930) income is taxable to the one who earns it, regardless of whether than person made a legally binding contract to have it paid to another. The fruit may not be "attributed to a different tree from that on which it grew."

In V. Borge, 26 TCM 816, Victor Borge, the pianist-comedian, made a contract with his controlled corporation to provide entertainment services. IRC Section 482 was used to allocate income to Borge individually.

In W. H. Bell, III, 45 TCM 97, three physicians formed a professional corporation and a separate S corporation. The S corporation earned income from providing X-ray services to the professional corporation. IRC Section 482 was used to allocate income from the S corporation to the C corporation. The income allocated was then treated as dividend distributions from the C corporation to its shareholders. If an existing business is transferred to multiple corporations, the examiner, in addition to considering section 482, should consider the applicability of sections 269 and 1551.

In R. Rubin, 72-1 USTC 9440, payments by Corporation A to Corporation B were allocated under section 482 to the shareholder of Corporation B who had performed the management services for Corporation A. The taxpayer's services constituted a trade or business separate from his interest in Corporation B.

P. W. Ach, 42 TC 114, the taxpayer sold her successful dress shop to her son's insolvent corporation for less than adequate consideration. Although the taxpayer continued to provide significant managerial services to the business, she was not remunerated for her services. The court upheld the Service's use of IRC section 482 to allocate 70% of the profits of the dress shop to the taxpayer. The court held the parties had not dealt at arm's length and the sole purpose for the transfer of the dress shop was for the corporation to utilize net operating losses it would have otherwise lost.

A shareholder's rental of a commercial building to his/her controlled corporation for no rent or for less than fair rental is subject to IRC section 482. D. A. Peck, 43 TCM 291. See also, Fegan v. Commissioner, 71 TC 791; R. Cooper, 64 TC 476; J. J. Thomas, 46 TCM 974.

This may be particularly abusive in situations where the corporation has a net operating loss. To the extent the shareholder has an allowable rental loss after applying section 482 and any other relevant provisions of the Code, IRC section 469 should be considered to disallow any passive activity loss.

A partnership's rental of a building to a related corporation for no rent or for less than fair rental is also subject to IRC section 482. R. A. Boyer, 58 TC 316.

Per regulation 1.482-4(b), intangible property for purposes of IRC section 482 includes:

There are numerous cases involving the sale of goods between a controlled domestic corporation and a controlled foreign corporation. A referral to International Specialists is required in these cases.

In accordance with Rev. Rul. 69-630, 1969-2 CB 112, (as modified by 1999-2 I.R.B. 41) in the cases of a bargain sale between two corporations owned by the same shareholder, the income of the seller will be increased to reflect the arm's-length price, and the basis of the property to the purchaser will be increased by a like amount. Additionally, the amount of the increase will be treated as a distribution by the selling corporation to the shareholder and as a capital contribution by the shareholder to the purchasing corporation, unless the transaction giving rise to the section 482 allocation did not have as one of its principal purposes the avoidance of income tax. Rev. Proc. 65-17, 1965-1 CB 833.

The sale of property by a shareholder to his controlled corporation is subject to section 482. C. O. Anderson, 35 TCM 101. The sale of land by a partnership to its controlling corporate partner is also subject to IRC section 482. Aladdin Industries, 41 TCM 1515.

Following a disproportionate distribution of property from their partnership, the partners contributed the land to a charitable organization. IRC Section 482 was applied to allocate the charitable contributions among the partners consistent with the percentage interests in the partnership. R. M. Dolese, 82 TC 830.

Similarly, in Northwestern National Bank of Minneapolis, 556 F.2d 889 (1977), the Service successfully reallocated to a wholly-owned subsidiary a charitable deduction claimed by the parent consisting of assets acquired from the subsidiary by means of an upstream dividend. The subsidiary in this case acquired 10% of the stock of a company for a cost of $100,000. Over time the fair market value of the stock rose to $800,000. After consideration of various alternatives, the subsidiary declared a dividend to its 100% corporate parent of the stock. Within two weeks of receiving its "dividend " , the parent donated the stock to a charitable foundation. The taxpayer argued IRC section 482 was inapplicable to a transaction that originated as a dividend distribution. In addressing this, the court stated:

Section 482 controls when it conflicts with section 351 as long as the Commissioner does not abuse his discretion to reallocate income and expenses. F. L. Rooney, 62-2 USTC 9598. In footnote 4, the court in Aladdin Industries, 41 TCM 1515, stated: "It has been routinely held, absent an abuse of discretion by the Commissioner, section 482 will override specific non-recognition provisions of the code. National Securities Corp. v. Commissioner, 137 F.2d 600 (3d Cir. 1943), cert. denied 320 US 794 (1943); Central Cuba Sugar Co. V. Commissioner, 198 F.2d 214 (2d Cir. 1952), cert. denied 344 US 874 91952) . . ."

A statement will be made in the report to the primary taxpayer to the effect that:

The correlative adjustment should not be made until the primary adjustment has been resolved. Per Treas. Reg. 1.482-1(d)(2), the primary adjustment may be resolved in one of the following ways:

To provide uniform treatment of all IRC 482 cases, agreed or unagreed, reports on the primary taxpayer and the correlative taxpayer should be prepared concurrently; kept together (not separate) and transmitted to the next function (i.e., Technical Services, Appeals Office, or campus processing center).

In cases with no tax effect of a correlative adjustment (foreign entity, loss entity, etc.), the examiner should make a statement in the preliminary statement to the effect that the correlative adjustment is deemed to have been made when and if the adjustments are agreed to and assessment has been made or deficiency has been paid. It is important that this statement included in all reports in order that the taxpayer to which the correlative adjustments apply may not escape the effect of these adjustment in the event of a subsequent exam or carryback of losses or credits or other events which do have a tax effect.

To ensure that overpayments resulting from the correlative adjustments are not scheduled and refunded to the taxpayer, the examiner will note Form 3198 accordingly.