Question

During a recent IRS audit, the revenue agent decided that Apple, an individual, used his closely-held corporation, Fruit Tree Inc., to avoid shareholder tax by accumulating earnings beyond the reasonable needs of the business. Fruit Tree Inc.'s taxable income for the year was $550,000 and it paid no dividends. Compute Fruit Tree Inc.'s accumulated earnings tax, assuming that it had accumulated $143,000 after-tax income in prior years. Also assume that the accumulated earnings tax rate is 20% and up to $250,000 can be accumulated without incurring the accumulated earnings tax.

a. $110,000
b. $60,000
c. $88,600
d. $93,500

Answer 1

Fruit Tree Inc.'s accumulated earnings tax is calculated by subtracting the allowed accumulation of $250,000 from their taxable income, adding prior accumulated earnings, and applying the tax rate of 20% to the result. The correct accumulated earnings tax amount is $88,600.

Step-by-step explanation:

Calculation of Accumulated Earnings Tax for Fruit Tree Inc.

The question pertains to the accumulated earnings tax that may be assessed on a corporation if the Internal Revenue Service (IRS) determines that the corporation is retaining earnings beyond the reasonable needs of the business, typically for the purpose of shielding shareholders from taxes on dividends.

To calculate the accumulated earnings tax for Fruit Tree Inc., we first apply the threshold provided by tax law. As stated, corporations are allowed to accumulate a certain amount of earnings, which is $250,000 according to the information provided, without incurring this tax. Therefore, we subtract this amount from the $550,000 taxable income of Fruit Tree Inc. to find the taxable excess earnings.

$550,000 taxable income - $250,000 allowed accumulation = $300,000 excess earnings

Since Fruit Tree Inc. also had $143,000 of after-tax income accumulated from prior years, we add this amount to the excess earnings to get the total accumulated taxable earnings:

$300,000 excess earnings + $143,000 prior accumulated earnings = $443,000 total accumulated taxable earnings

The accumulated earnings tax is then calculated as 20% of the $443,000 total accumulated taxable earnings.

$443,000 x 20% = $88,600

Therefore, the correct answer to the question is option (c) $88,600.