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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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.
The TCJA has also breathed new life into the tax-avoidance rules under Internal Revenue Code Section 531 (the accumulated earnings tax, or AET) and Section 541 (the undistributed personal holding company tax, or PHCT), which had limited applicability in recent years due to high U.S.
The accumulated earnings tax applies to all C corporations, without regard to the number of shareholders in taxable years beginning after July 18, 1984.
(5) It is questionable whether many corporations could accumulate sufficiently large cash reserves for effective partial stock redemptions without running afoul of the prohibition against the unreasonable accumulation of earnings (see page 362, Accumulated Earnings Tax).
If the corporation has accumulated earnings of more than $250,000 ($150,000 for certain service corporations) then the further accumulation of income to pay life insurance premiums for key employee insurance potentially exposes the corporation to the accumulated earnings tax. There are, however, many exceptions to the application of this tax.
(9) The accumulated earnings tax may be imposed on a corporation that has E&P in excess of the reasonable needs of the business.
The corporation is experiencing an accumulated earnings tax problem.
Moreover, there appears to be little possibility that the accumulated earnings tax would apply to the retained earnings of the U.S.
Question--Will life insurance owned by the corporation to fund the Section 303 redemption cause or aggravate an accumulated earnings tax problem?
* 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
* Accumulating assets inside the business might subject the business to the "accumulated earnings tax" if it has accumulated beyond the "reasonable needs of the business."
This article explores planning opportunities and defense strategies for corporations potentially exposed to the accumulated earnings tax.

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