U.S. Corporations Accumulated Earnings Tax Introduction
The U.S. federal government levies an accumulated earnings tax on U.S. corporations when corporations?accumulated earnings are deemed unreasonable and exceed normal levels. The tax policy encourages U.S. corporations to pay dividends to shareholders rather than retain corporations?earnings. In addition, this tax policy is not a self-assessment type tax, and the US federal government can levy it through the review of US corporations. This article will briefly introduce accumulated earnings tax levy object, accumulated earnings tax exemption amount, accumulated earnings tax calculation method and the method of avoiding accumulated earnings tax, etc.
The main accumulated earnings tax collection object is corporations. Those listed corporations with many shareholders are also subject to the levy. It should be noted that the following four types of companies are not subject to accumulated earnings tax:
- A personal holding company as defined in Section 542 of the Federal Regulation codes.
- Tax-exempt corporations under subchapter F of Federal Regulation codes (Section 501 and following).
- Passive foreign investment companies as defined in Section 1297 of the Federal Regulation codes.
- S-corporations and other types of companies.
There are two types of exemptions for accumulated earnings tax:
- U.S. corporations may have accumulated earnings of up to $250,000 without incurring any accumulated earnings tax. The IRS considers the $250,000 limit to meet the reasonable business needs of most corporations.
- When providing personal services, a corporation is allowed to accumulate earnings of up to $150,000. Personal services mainly include accounting, actuarial science, architecture, consulting, engineering, health, law, etc.
If the accumulated earnings of a corporation exceed the exemption limit, the excess accumulated earnings will be subject to a 20% tax rate. Prior to 2013, excess accumulated earnings were taxed at 15%. The calculation formula is accumulated earnings tax = accumulated taxable income x 20%. Accumulated taxable income is generally subject to deductions for federal income tax-paid, dividends paid and a $250,000 exemption. In addition, interest on accumulated earnings tax is calculated from the initial due date of the corporate tax return and cannot be extended.
To avoid accumulated earnings tax, a corporation can take the following three measures:
- A corporation can avoid paying accumulated earnings tax by justifying its accumulated earnings. This justification should be recorded in the corporation’s minutes.
- To reduce accumulated earnings, a corporation should consider starting or increasing dividend payments. In addition, a corporation may draft a written document for the dividend payment policy.
- To reduce the accumulated earnings, the corporation may consider raising the compensation reasonably.
Accumulated earnings are reasonable when a corporation can demonstrate that the accumulated earnings are a reasonable business need. The following six are reasonable business needs permitted by the IRS:
- Acquiring other companies by purchasing stock or assets.
- Provide the working capital required for the business.
- Invest or lend to suppliers and customers.
- To expand the business or change the factory.
- Redemption of shares held by minority shareholders.
- Need to finance the pension or profit-sharing plans for the employer.
Reference:
https://www.irs.gov/publications/p542
https://www.irs.gov/irm/part4/irm_04-010-013
https://www.law.cornell.edu/uscode/text/26/532
https://thismatter.com/money/tax/corporate-accumulation-penalty-taxes.htm
https://frostbrowntodd.com/how-corporations-may-run-afoul-of-the-accumulated-earnings-tax-a-section-1202-planning-brief/
https://www.krdcpas.com/strategies-for-avoiding-the-accumulated-earnings-tax/ |
