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Old 02-07-2007, 03:49 PM
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Question What is the significance of having Retained Earnings in a Corporation?

Dear TaxGuru,

I fail to understand why some C corporations have taxable income especially, based on your prior posts you suggested strategies to avoid double taxation.

On what basis then should a C Corporation of have residual taxable income and why should a client leave any taxable profits at the end of the taxable year?

Grateful for your answer, tks..



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Old 02-18-2007, 08:07 PM
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Excellant question!

Well, today there are several small corporations that have a need to leave some residual profits within the corporations. You are right, that these profits would be subject to double taxation.

But, the business requirements far outweigh the tax planning strategy of eliminating taxable income.

Why do small corporations leave residual taxable income and pay corporation tax?

Financial Institition Loan Covenants
Firstly, the Corporation has to meet all of its covenants to the bankers or institutions it has borrowed loans. One of the conditions may be to maintain cashflow or residual income to cover 12 months of loan payments.

Or, simply, the corporations is attempting to obtain a line of credit that is solely affected by net income or residual profits of the Corporations. Hence, if there was immaterial profit the banker would be reluctant to extend the Line of credit or provide a new substantial line of credit.

Management Decision to maintain adequate cashflow
Secondly, the board of directors or management of the business has determined that the business must maintain adequate cashflow to fund the business cash needs of business. Also, retained earnings might be the cheapest source of income! Hence, the desire not to distribute all the profits through bonuses and salary.

Business requirements for IT staffing and consulting corporations
Additionally, we see a lot of small C corporations especially if they are an IT consulting C-Corporation, who specialise in Staffing and H-1 placement, display a tendancy to leave residual income at year end. Most of these companies need to demonstrate to the INS that they have the ability to pay a salary to a new H-1 Consultant. Once again, this is a situation where the business requirement dictates how much profits need to be shown for tax purposes.

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Last edited by TaxGuru : 02-18-2007 at 08:15 PM.


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