[Code of Federal Regulations]
[Title 26, Volume 7]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.535-3]

[Page 247-249]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.535-3  Accumulated earnings credit.

    (a) In general. As provided in section 535(a) and Sec. 1.535-1, the 
accumulated earnings credit, provided by section 535(c), reduces taxable 
income in computing accumulated taxable income. In the case of a 
corporation, not a mere holding or investment company, the accumulated 
earnings credit is determined as provided in paragraph (b) of this 
section and, in the case of a holding or investment company, as provided 
in paragraph (c) of this section.
    (b) Corporation which is not a mere holding or investment company--
(1) General rule. (i) In the case of a corporation, not a mere holding 
or investment company, the accumulated earnings credit is the amount 
equal to such part of the earnings and profits of the taxable year which 
is retained for the reasonable needs of the business, minus the 
deduction allowed by section 535(b)(6) (see paragraph (f) of Sec. 
1.535-2, relating to the deduction for long-term capital gains). In no 
event shall the accumulated earnings credit be less than

[[Page 248]]

the minimum credit provided for in section 535(c)(2) and subparagraph 
(2) of this paragraph. The amount of the earnings and profits for the 
taxable year retained is the amount by which the earnings and profits 
for the taxable year exceed the dividends paid deduction for such 
taxable year. See section 561 and Sec. Sec. 1.561-1 and 1.561-2, 
relating to the deduction for dividends paid.
    (ii) In determining whether any amount of the earnings and profits 
of the taxable year has been retained for the reasonable needs of the 
business, the accumulated earnings and profits of prior years will be 
taken into consideration. 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 business. See section 537 and Sec. Sec. 
1.537-1 and 1.537-2.
    (2) Minimum credit. Section 535(c)(2) provides for the allowance of 
a minimum accumulated earnings credit in the case of a corporation which 
is not a mere holding or investment company. Except as otherwise 
provided in section 243(b)(3) and Sec. 1.243-5 (relating to effect of 
100-percent dividends received deduction under section 243(b)) and 
sections 1561, 1562, and 1564 (relating to limitations on certain tax 
benefits in the case of certain controlled corporations), in the case of 
such a corporation, this minimum credit shall in no case be less than 
the amount by which $150,000 ($100,000 in the case of taxable years 
beginning before January 1, 1975) exceeds the accumulated earnings and 
profits of the corporation at the close of the preceding taxable year. 
See paragraph (d) of this section for the effect of dividends paid after 
the close of the taxable year in determining accumulated earnings and 
profits at the close of the preceding taxable year. In determining the 
amount of the minimum credit allowable under section 535(c)(2), the 
needs of the business are not taken into consideration. If the taxpayer 
has accumulated earnings and profits at the close of the preceding 
taxable year equal to or in excess of $150,000 ($100,000 in the case of 
taxable years beginning before January 1, 1975), thecredit, if any, is 
determined without regard to section 535(c)(2). It is not intended that 
the provision for the minimum credit shall in any way create an 
inference that an accumulation in excess of $150,000 ($100,000 in the 
case of taxable years beginning before January 1, 1975) is unreasonable. 
The reasonable needs of the business may require the accumulation of 
more or less than $150,000 ($100,000 in the case of taxable years 
beginning before January 1, 1975), depending upon the circumstances in 
the case, but such needs shall not be taken into consideration to any 
extent in cases where the minimum accumulated earnings credit is 
applicable. For a discussion of the reasonable needs of the business, 
see section 537 and Sec. Sec. 1.537-1, 1.537-2, and 1.537-3.
    (3) Illustrations of accumulated earnings credit. The computation of 
the accumulated earnings credit provided by section 535(c) may be 
illustrated by the following examples:

    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        $55,000
 retained for the reasonable needs of the business............
Less: The deduction for long-term capital gains (less              5,000
 applicable tax) allowed under sec. 535(b)(6).................
                                                               ---------
    Accumulated earnings credit allowable under sec. 535(c)(1)    50,000



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    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).

    (c) Holding and investment companies. Section 535(c)(3) provides 
that, in the case of a mere holding or investment company, the 
accumulated earnings credit shall be the amount, if any, by which 
$150,000 ($100,000 in the case of taxable years beginning before January 
1, 1975) exceeds the accumulated earnings and profits of the corporation 
at the close of the preceding taxable year. Thus, if such a corporation 
has accumulated earnings equal to or in excess of $150,000 ($100,000 in 
the case of taxable years beginning before January 1, 1975) at the close 
of its preceding taxable year, no accumulated earnings credit is 
allowable in computing the accumulated taxable income. See paragraph (c) 
of Sec. 1.533-1 for a definition of a holding or investment company. 
For the accumulated earnings credit of a mere holding or investment 
company which is a member of an affiliated group which has elected the 
100-percent dividends received deduction under section 243(b), see 
section 243(b)(3) and Sec. 1.243-5. For the accumulated earnings credit 
of a mere holding or investment company which is a component member of a 
controlled group of corporations (as defined in section 1563), see 
sections 1561, 1562, and 1564.

(Sec. 1561(a) (83 Stat. 599; 26 U.S.C. 1561(a)))

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6992, 34 FR 
826, Jan. 18, 1969; T.D. 7181, 37 FR 8066, Apr. 25, 1972; T.D. 7244, 37 
FR 28897, Dec. 30, 1972; T.D. 7376, 40 FR 42744, Sept. 16, 1975; T.D. 
7528, 42 FR 64694, Dec. 28, 1977]