ACCUMULATED EARNINGS TAX Meaning and
Definition
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The term "accumulated earnings tax" refers to a tax that is imposed by the Internal Revenue Service (IRS) in the United States on corporations that retain excessive earnings instead of distributing them to shareholders. It is designed to prevent shareholders from avoiding individual income tax by retaining corporate earnings.
Under the accumulated earnings tax, corporations are required to distribute earnings and profits to shareholders as dividends, unless they can demonstrate a legitimate business purpose for retaining the excess earnings. The tax aims to discourage the accumulation of earnings beyond the reasonable needs of the business.
The accumulated earnings tax is intended to apply to profitable corporations that have retained earnings in excess of a reasonable level necessary for the business's ongoing operations, expansion, or investment needs. The IRS determines the reasonable level of accumulated earnings based on factors like the nature of business, industry standards, future business or investment plans, and the financial stability of the company.
Any accumulated earnings deemed excessive can be subject to a penalty tax rate, which is currently set at 20%. This would be in addition to the regular corporate income tax rate. Corporations can avoid the accumulated earnings tax by making legitimate distributions as dividends or by reinvesting excessive earnings in the business for valid reasons. Failure to comply with the regulations may result in tax liability and potential penalties for the corporation.
