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.

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.
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The policy reasons for the accumulated earnings tax are similar to PFICs--both sets of rules are intended to apply to a corporation that is holding liquid assets for investment, rather than its active business needs (see H.
subsidiary would be forced to make distributions in order to avoid application of the accumulated earnings tax (83) for retaining earnings.
collectively "Metro") paid a 1995 contested tax liability in 2001 based on their calculation of the accumulated earnings tax.
Consequently, as with the personal holding company tax, the accumulated earnings tax penalizes a corporation for failing to distribute earnings which are not needed for legitimate business purposes.
The accumulated earnings tax has no application to S Corporations, since there is no double taxation.
The IRS assessed deficiencies for the three years, disallowing the bonuses and imposing the accumulated earnings tax.
Other benefits included the ability to distributed accumulated S income to shareholders free of income tax and the inapplicability to S corporations of the accumulated earnings tax (AET).
3] The company's potential exposure to the alternative minimum tax, environmental tax and accumulated earnings tax should be considered before revoking the S election.
In a decision filed on Friday, February 19, 1993, by Judge Rosenbaum, the Federal District Court ruled that the IRS had improperly applied the accumulated earnings tax to Network Systems for 1983 through 1985.
To prevent companies from doing this, Congress adopted the excess accumulated earnings tax provision of IRC section 535.
2) Although some S corporation advantages remain (such as the increase in a shareholder's basis for income retained in the business, and the absence of the corporate alternative minimum tax (AMT), personal holding company (PHC) tax and accumulated earnings tax (AET)), the S corporation should not always be the entity of choice.
Practitioners must be cognizant of the basic rules surrounding the accumulated earnings tax (AET) and be prepared to advise their clients on how to avoid this "penalty tax" before the Service raises the issue.

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