United States v. Donruss Co.
393 U.S. 297 (1969)
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Rule of Law:
To trigger the accumulated earnings tax under IRC §§ 531-537, avoidance of shareholder income tax need only be one of the purposes for an unreasonable accumulation of corporate earnings, not the dominant, controlling, or impelling purpose.
Facts:
- The Donruss Co. was a corporation engaged in manufacturing bubble gum and candy, wholly owned by Don B. Wiener since 1954.
- From 1955 to 1961, Donruss was consistently profitable, increasing its undistributed earnings from approximately $1 million to $1.68 million.
- Throughout this entire period, Donruss did not declare or pay any dividends to its sole shareholder, Wiener.
- Wiener asserted that the earnings were retained for various business reasons, including capital requirements, rising costs, and a general desire to expand.
- Specifically, Wiener expressed a desire to invest in a major distributor, but there were no definite plans for this investment during the tax years in question (1960-1961).
- In 1964, several years after the tax period in question, Donruss did purchase shares in the distributor company for $380,000.
Procedural Posture:
- The Commissioner of Internal Revenue assessed accumulated earnings taxes against Donruss Co. for 1960 and 1961.
- Donruss paid the tax and then filed a refund suit against the United States in federal district court (a trial court).
- The trial court refused the government's jury instruction that tax avoidance need only be 'one of the purposes', instead instructing that it must be 'the purpose'.
- A jury found that although Donruss accumulated earnings beyond its reasonable business needs, it did not do so for the purpose of tax avoidance.
- The district court entered judgment for Donruss.
- The United States (appellant) appealed to the U.S. Court of Appeals for the Sixth Circuit.
- The Court of Appeals (appellee: Donruss) reversed and remanded, holding the correct test was whether tax avoidance was the 'dominant, controlling, or impelling motive'.
- The United States (petitioner) sought and was granted a writ of certiorari by the U.S. Supreme Court to resolve a circuit split on the issue.
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Issue:
Does the accumulated earnings tax apply when avoidance of shareholder income tax is one of the purposes for a corporation's unreasonable accumulation of earnings, or must it be the dominant, controlling, or impelling purpose?
Opinions:
Majority - Justice Marshall
Yes, the accumulated earnings tax applies if avoidance of shareholder income tax is one of the purposes for an unreasonable accumulation. The legislative history of the statute demonstrates a persistent congressional concern with corporations being used to avoid shareholder taxes and the difficulty of proving a corporation's subjective motive. To effectuate the statute's purpose, Congress created a presumption that an unreasonable accumulation is for a tax-avoidance purpose. Requiring the government to prove that tax avoidance was the 'dominant' or 'impelling' motive would exacerbate the evidentiary problem Congress sought to solve and would allow taxpayers to easily rebut the presumption with self-serving testimony about other business needs, effectively nullifying the tax. The proper standard is whether the proscribed purpose contributed to the decision to accumulate, not whether it was the most important reason.
Concurring-in-part-and-dissenting-in-part - Justice Harlan
No, while the 'dominant motive' test is incorrect, the majority's 'one of the purposes' test is also flawed because it is too harsh. In nearly every closely held corporation, shareholders will be aware of the tax savings from accumulating earnings. A jury hearing the majority's instruction will likely find the forbidden purpose exists whenever there is mere knowledge of the tax benefit, effectively denying the taxpayer the 'last clear chance' Congress intended to provide to prove a contrary purpose. The proper standard should be a 'but for' test: the tax should apply only if the jury finds that the taxpayer would not have accumulated the earnings but for its knowledge that a tax saving would result.
Analysis:
This decision significantly lowers the burden on the government in accumulated earnings tax cases by clarifying a circuit split in its favor. By establishing that tax avoidance need only be 'one of the purposes' for an accumulation, the Court makes it much more difficult for taxpayers to rebut the statutory presumption that arises once an accumulation is found to be unreasonable. The ruling effectively shifts the primary focus of litigation from the subjective motive of the taxpayer to the more objective question of whether the retained earnings exceeded the 'reasonable needs of the business.' This provides the IRS with a more powerful tool to combat the use of corporations as personal tax shelters.
