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Old 11-08-2007, 10:17 PM
Join Date: Jan 2007
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What is Accumulated Earnings Tax and when is it applicable to my Corporation?

I have read somewhere that C corporations are subject to something called accumulated earnings tax!

I really dont understand this tax and was wondering if you could shed some light on this and whether or not a small C corporation would be subject to this tax.


Last edited by abax : 01-09-2008 at 04:37 PM.

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Old 01-05-2008, 09:51 PM
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What is the Accumulated Earnings Tax?

Generally, C Corporations are subject to double taxation, one applied at the corporation level and the other applied at the individual level that is based on the dividend distribution being taxed on the individual tax return. Most taxpayers are aware of this feature, but, many are not aware of the Accumulated Earnings Tax.

What is the Accumulated Earnings Tax?
Accumulated earnings tax is a tax imposed by the IRS on Corporations with retained earnings that is "deemed to be unreasonable and in excess of what is considered ordinary".

What are Retained Earnings?
When a C Corporation makes a profit, it is subject to Corporation Tax based on a graduated tax rate. After paying the corporation tax, the portion of profit that is not distributed as Dividends is called Retained Earnings. When these retained earnings are being accumulated over the years, the amount of retained earnings can get substantial, especially when these are not distributed out in the form of dividends to the shareholders.

Now, Corporations have realised that by distributing these retained earnings to the individual shareholders, these dividends would again then be taxed on the individual shareholder resulting in double taxation of corporation taxes, once at the corporate level and then again at the individual level. Corporations have clearly an incentive not to distribute the dividends from retained earnings to avoid the dividend income.

What is the Accumulated Earnings Tax Rate?
The IRS imposes an additional "accumulated earnings" tax of 15 percent on retained earnings of a corporation that accumulates above $250,000. The IRS has established a limit of acceptable retained earning of $150,000 for certain "personal service corporations" (i.e., corporations in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts or consulting, where the owners provide the services). As discussed above, this tax is only applicable to 'C' Corporations.

What is the purpose of this Accumulated Earnings Tax?
This tax is designed to penalise corporations from accumulating retained earnings just to avoid paying taxable dividends from being taxed again. For US publicly traded companies, the dividend distribution is kept at a minimum to acheive a higher share price for its shareholders.

To answer your specific question whether or not a small corporation needs to worry about this tax, well, it depends on how much retained earnings have been accumulated over the years, if the amounts does not exceed the IRS limits then clearly this tax would not be applicable.

If accumulated earnings limits are exceeding IRS limits then there would have to be dividend distributions from retained earnings. If no such distributions have been made despite exceeding the IRS limits above, then I would be concerned about the IRS imposing the Accumulated Earnings Tax.

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