accumulated earnings tax

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Accumulated Earnings Tax

In the United States, a tax on a corporation for retained earnings the IRS deems to be excessive. Retained earnings are profits that are not paid out in dividends. Companies with a low payout ratio generally experience higher price appreciation on their stock, which would subject shareholders to a higher capital gains tax when they sell, rather than a higher tax on dividends. However, the tax rate on capital gains is lower than the tax on dividends. Thus, the accumulated earnings tax exists to ensure that the government is able to receive roughly the same amount in revenue regardless of how much or how little the corporation distributes in dividends.
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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.
Wall Street Words: An A to Z Guide to Investment Terms for Today's Investor by David L. Scott. Copyright © 2003 by Houghton Mifflin Company. Published by Houghton Mifflin Company. All rights reserved. All rights reserved.
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When deferred compensation plans are used by closely held corporations and are maintained for a long time, resulting in large accumulations of capital by the corporation to fund the plan, it is possible the IRS may try to impose the accumulated earnings tax. However, in the Scripps Newspapers case, the Tax Court held that the accumulation of earnings to fund a nonqualified plan is a valid business purpose (John P.
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* the potential imposition of penalty taxes, such as the accumulated earnings tax applicable to corporations that retain earnings in excess of the reasonable needs of the business
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This article explores planning opportunities and defense strategies for corporations potentially exposed to the accumulated earnings tax.

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