William Queen owns all the stock in Able and Baker Corporations. Able, a successful enterprise, has generated excess working capital of $3 million. Baker is still in its developmental stages and has had substantial capital needs. To meet some of these needs, William had Able lend Baker $2 million during Year 1 and Year 2. These loans are secured by Baker notes, but not other Baker property. Able has charged Baker interest at a rate ordinarily charged by a commercial lender. Upon reviewing Able’s books in the audit of its Year 1 tax return, an IRS agent indicates that Able is liable for the accumulated earnings tax because of its build up of excess working capital and its loans to Baker. Later this week, you will meet with the agent for a third time. Before this meeting, you must research whether loans to a related corporation to finance its working capital meet a reasonable need of the business. At a meeting to discuss this problem, William asks whether filing a consolidated tax return would eliminate this potential problem and, if so, how must the ownership structure change to accomplish this objective.
A partial list of research sources is
• IRC Secs. 532 and 537
• Reg. Secs. 1.537-2(c) and -3(b) and 1.1502-43
• Latchis Theatres of Keene, Inc. v. CIR, 45 AFTR 1836, 54-2 USTC ¶9544 (1st Cir., 1954)
• Bremerton Sun Publishing Co., 44 T.C. 566 (1965)