A corporation can accumulate its earnings for a possible expansion
or other bona fide business reasons. However, if a corporation allows
earnings to accumulate beyond the reasonable needs of the business, it
may be subject to an accumulated earnings tax of 39.6%. If the
accumulated earnings tax applies, interest applies to the tax from the
date the corporate return was originally due, without extensions.
To determine if the corporation is subject to this tax, first treat
an accumulation of $250,000 or less generally as within the reasonable
needs of most businesses. Treat an accumulation of $150,000 or less as
within the reasonable needs of a business whose principal function is
performing services in the fields of accounting, actuarial science,
architecture, consulting, engineering, health (including veterinary
services), law, and the performing arts.
In determining if the corporation has accumulated earnings and
profits beyond its reasonable needs, value the listed and readily
marketable securities owned by the corporation and purchased with its
earnings and profits at net liquidation value, not at cost.
Reasonable needs of the business include the following.
- Specific, definite, and feasible plans for use of the
earnings accumulation in the business.
- The amount necessary to redeem the corporation's stock
included in a deceased shareholder's gross estate, if the amount does
not exceed the reasonably anticipated total estate and inheritance
taxes and funeral and administration expenses incurred by the
shareholder's estate.
The absence of a bona fide business reason for a corporation's
accumulated earnings may be indicated by many different circumstances,
such as a lack of regular distributions to its shareholders or
withdrawals by the shareholders classified as personal loans. However,
actual moves to expand the business generally qualify as a bona fide
use of the accumulations.
The fact that a corporation has an unreasonable accumulation of
earnings is sufficient to establish liability for the accumulated
earnings tax unless the corporation can show the earnings were not
accumulated to allow its individual shareholders to avoid income tax.
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