Question - Convention Corporation is a leading manufacturer of advanced convention communication equipment. As the equipment requires the approval of various Federal agencies, Convention Corporation spends a fortune on lobbying efforts. The family-owned business has prospered for many years and has generated approximately $300 million of sales and $90 million in after-tax profits.
Your accounting firm has performed the audit and tax work for the corporation and its executives since the company was formed when Jimmy Carter was the President of the United States.
The difficulty of getting advanced communication equipment approved has kept the overall market size constant, and the corporation plans no major plant expansions or additions. The potential and actual regulation seems to provide significant barriers to entry.
You have been assigned to oversee the preparation of the 2015 Convention Corporation tax returns.
Salaries paid to Convention Corporation executives, most of whom are family members, are significantly above the national average for similar positions. Dividend payments in recent years have not exceeded 3% of the after-tax profits. You note from schedule L (the balance sheet) that the corporation has made over $6.5M in loans to three top family member executives and during the period between January 1, 2012 and today, these loans have increased significantly. Interest is generally paid through increasing the loan amounts. You also note that the Corporation regularly has increased the size of its stock portfolio between 2008 and 2015. It has begun to dawn on you that Convention Corporation may be liable for accumulated earnings tax in 2015 and prior years.
Required:
Prepare a memorandum to Marco Gingrich, your tax manager, regarding all appropriate issues with respect to the accumulated earnings tax. In your memorandum, discuss the following three questions and any other matters and suggestions you believe to be relevant:
1. What responsibility do you have to make Convention Corporation or the partner in charge of the account aware of the potential accumulated earnings tax liability? (Discuss the liability, if any, of your firm.)
2. Should you advise the IRS of the potential liability for prior years? Should you disclose the potential liability on the current year return?
3. Should the company disclose the issue in its 2015 tax return or inform the IRS by letter?
4. Prepare a list of actions that can be taken to reduce or eliminate the client's potential liability for the accumulated earnings tax.