accumulated earnings tax

Accumulated Earnings Tax

A tax imposed by the federal government upon companies with retained earnings deemed to be unreasonable and in excess of what is considered ordinary.

Notes:

The federal government produced this tax to deter investors from negatively influencing a company's decision to pay dividends. Essentially, this tax persuades companies to issue dividends, rather than retaining the earnings.

The premise behind this tax is that companies that retain earnings typically experience higher stock price appreciation. Although this is beneficial to stockholders, as capital gains taxes are lower than dividend taxes, it is detrimental to the government because tax revenues decrease. By adding an extra tax upon a firm's retained earnings, the taxman will either collect more taxes from the company or persuade them to issue dividends, thereby allowing the government to collect from the stockholders.

See also: Capital Gain, Dividend, IRS, Retained Earnings

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accumulated earnings tax

A federal tax on a company's retained earnings that are considered in excess of what is reasonable. The purpose of an accumulated earnings tax is to make it more difficult to defer or lower the tax rate (that is, change from ordinary income to capital gains) on income that would ordinarily be paid to stockholders in dividends. For example, stockholders in high tax brackets generally prefer earnings be retained rather than paid in dividends so that they can avoid being taxed at ordinary rates. The position of the Internal Revenue Service is that if the funds are not actually needed by the firm and are only being retained for tax reasons, the accumulated earnings should be taxed.