LO.4 Heron Corporation has been in operation for 10 years. Since Heron’s creation, all E THI C S AND EQUI TY of the stock has been owned by Andy, who initially invested $200,000 in the corporation.

Heron has been successful far beyond Andy’s expectations, and the current fair market value of the stock is $10 million. While he has been paid a salary of $200,000 per year by the corporation, all of Heron’s earnings have been reinvested in the growth of the corporation.

Heron is currently being audited by the IRS. One of the issues raised by the IRS agent is the possibility of the assessment of the accumulated earnings tax. Andy is not concerned about this issue because he believes Heron can easily justify the accumulations based on its past rapid expansion by opening new outlets. The expansion program is fully documented in the minutes of Heron’s board of directors. Andy has provided this information to the IRS agent.

Two years ago, Andy decided that he would curtail any further expansion into new markets by Heron. In his opinion, further expansion would exceed his ability to manage the corporation effectively. Since the tax year under audit is three years ago, Andy sees no reason to provide the IRS agent with this information.

Heron will continue its policy of no dividend payments into the foreseeable future.

Andy believes that if the accumulated earnings issue is satisfactorily resolved on this audit, it probably will not be raised again on any subsequent audits. Thus, double taxation in the form of the tax on dividends at the shareholder level or the accumulated earnings tax at the corporate level can be avoided.

What is Heron’s responsibility to disclose to the IRS agent the expected change in its growth strategy? Are Andy’s beliefs regarding future accumulated earnings tax issues realistic?
CRITICAL THINKING