What Is the Accumulated Earnings Tax?

The accumulated earnings tax is a tax imposed by the U.S. government on corporations with 澳洲幸运5官方开奖结果体彩网:retained earnings that are deemed to be excessive.

As the 澳洲幸运5官方开奖结果体彩网:Internal Revenue Service (IRS) explains, the accumulated earnings tax exists “to prevent a corporation from accumulating its earnings and profits beyond the reasonable needs of the business for the purpose of avoiding income taxes on its stockholders.”

How the Accumulated Earnings Tax Works

Corporations that accumulate earnings and profits above a certain level, instead of distributing them as taxable 澳洲幸运5官方开奖结果体彩网:dividends to their 澳洲幸运5官方开奖结果体彩网:shareholders, can be subject to 𒆙the accumulated earnings tax.

The 🍎level at which accumulated earnings become excessive depends on the “reasonable needs🌼” of that particular corporation.

By law, corporations are not required to pay dividends, and many do not, especially if their goal is to grow the business rather than produce regular dividend income for shareholders. For example, the IRS notes, “a corporation can accumulate its earnings for a possible expansion or other bona fide business reasons.” Tax avoidance, however, is a different matter.

Tax Avoidance

For that reason, any liability for the accumulated earnings tax is based on two conditions. In addition to accumulating more earnings and profits than are justifiable based on its needs, “There must be an intent on the part of the corporation to avoid the 澳洲幸运5官方开奖结果体彩网:income tax on its stockholders by accumulating earnings and profits instead of distributing them.”

The accumulated earnings tax penalty is 20% of the company’s accumulated taxable income for the year (or years). The IRS defines accumulated taxable income as “the corporation’s 澳洲幸运5官方开奖结果体彩网:taxable income with various adjustments, minus the dividends paid deduction and the accumulated earnings credit.”

Accumulated Earnings Credit

The minimum accumulated earnings credit is generally “the amount by which $250,000 exceeds the accumulated earnings and profits at the close of the preceding year,” according to the IRS. In other words, a company with up to $250,💙000 in accumulated earnings and profits is assumed to be within the limits for “reasonable needs.”

A lower number, $150,000, applies to businesses “whose principal function is performing services in the fields of accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and the performing arts.”

However, “accumulation in excess of the $250,000 minimum credit is not an indication of an unreasonable accumulation,” the IRS says, and the law sets no maximum credit. The maximum, according to the IRS, “is the amount of current earnings and profits retained for the reasonable needs of the business (adjusted for net capital gains).”

“These adjustments are made primarily for the purpose of arriving at an amount that corresponds more closely to financial reality and thus, measures more accurately the corporation’s dividend-paying capacity for the year,” the IRS explains.

Purpose of the Accumulated Earnings Tax

The ac𓃲cumulated earnings tax benefits the government by forcing corporations to pay out dividends when they have the money ava🍌ilable to do so and no other justifiable uses for that money.

That way, dividend income that shareholders receive as ordinary dividends can be taxed at the same rate as their earned income, providing the government with added revenue. Depending on shareholders’ total taxable income for the year and their marital status when they file, their income tax rate can range from 10% to 37%.

On the other hand, if the corporation simply retains that money, the shareholder won’t face any tax consequences unless they sell their shares, possibly many years later. In addition, when they do sell, they’ll owe tax on any profit they make at the more favorable rate for 澳洲幸运5官方开奖结果体彩网:capital gains. For most people, that rate will be 15% or less, compared with as much as 37% for dividends.

Exemptions From the Accumulated Earnings Tax

In addition to exempting a certain amount of earnings on the basis of “reasonable needs” for companies that are subject to the accumulated earnings tax, the law exempts several types of companies from the tax altogether. Those are:

• Personal holding companies
• Corporations exempt from tax under Subchapter F of the tax code (such as nonprofits and private foundations)
• 澳🌳洲幸运5官方开奖结果体彩网:Passive foreign investment companies

The Bottom Line

When corporations pay dividendsꦡ to their shareholders, the government receives a cut in the form of income taxes paid by those shareholders. If corporations decide to retain their earnings and profits instead of paying them out as dividends, the government may want to know why.

If the business can estab🐲lish that 🥀it has a “reasonable need” for doing so, that can be acceptable. However, if a company’s motivation appears to be tax avoidance, it can be subject to an accumulated earnings tax of 20%.

More information on the accumu൲lated earnings tax is available online in .