Watch Out for Accumulated Earnings Tax
Corporations have an incentive to retain earnings, rather than distribute them to shareholders, to avoid, or at least delay, double taxation. The accumulated earnings tax (AET) is designed to discourage that practice. If the IRS concludes that a corporation is retaining unreasonably high levels of earnings, then it may assess the AET — a 20% penalty tax on the corporation’s accumulated taxable income.
To determine a corporation’s accumulated taxable income, a CPA takes the corporation’s taxable income, subtracts dividends paid and an accumulated earnings credit, and makes certain other adjustments. The accumulated earnings credit allows corporations to accumulate up to $250,000 in earnings ($150,000 for certain service corporations) without fear of triggering the AET.
If a corporation has accumulated taxable income, the IRS may impose AET if it finds that the corporation is retaining, rather than distributing, earnings beyond the “reasonable needs of the business.” To avoid the tax, a corporation should be prepared to explain and document its need to retain earnings for working capital, business expansion, equipment purchases or other purposes.
This material is generic in nature. Before relying on the material in any important matter, users should note date of publication and carefully evaluate its accuracy, currency, completeness, and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances.
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