Accumulated Earnings Tax
|Accumulated Earnings Tax|
Accumulated earnings tax is a tax imposed by the government. The shareholders of a corporation tend to accumulate their profits in order to avoid tax and the accumulated earnings tax was created to keep them from doing it and inspire them to rather use their earnings to issue dividends. It is introduced in addition to usual corporate income tax. It is imposed with a rate of 20 percent on amounts presumed to be unreasonable aggregations of earnings. Accumulated Earnings Tax has existed in some form since 1913 (Madeo A.S, 1979, p.538).
With the exception of service corporations, for instance accounting, law and health care corporations, all corporations's first $250, 000 in accumulated earnings is exempt from tax. The first $150,000 of the service corporations shall not be taxed. The tax will not be imposed on accumulations, that can be considered mandatory to meet understandable needs of the business, even after the accumulated earnings of a corporation exceed the exemption tally.
Example of the accumulated earnings tax
"Alder is a manufacturing corporation that has accumulated earnings of $625,000. The corporation can establish reasonable needs for $450,000 of this accumulation. Alder Corporation would be subject to the accumulated earnings tax on $175,000 ($625,000-$450,000). The amount of the accumulated earnings tax is $35,000 (20% of $175,000)." (Gerald E. Whittenburg, Steven Gill and Martha Altus-Buller, 2017).
Differences in individual and corporate tax rate
The differences are thin enough to generate a temptation to use a corporation "as a shield against individual income tax". That is why the Congress made a move and disposed of this temptation by taxing the shareholders of offending corporations. Today's accumulated earnings tax is a spiritual successor to this early legislation (Doernberg R.L, 1981, p.715)
Enforcement process of the accumulated earnings tax
There are three parties that are interested in how the law in enforced. These are; Congress, The Treasury Department and taxpayers. There are also at least three stages in this process that can help determining the factors of these parties (Madeo A.S,1979, p.538):
- "The first stage - the point at which taxpayers are audited for possible accumulated earnings liability."
- "The second stage - the point at which taxpayers actually receive assessment from the Internal Revenue Service."
- "The third stage - the point at which cases are decided at court."
(Madeo A.S, p.538)
Definition by one od the scholars
According to scholar Homer L. Elliot accumulated earnings tax is often referred to as "a penalty on success itself". In his opinion, of all existing taxes, this is the most infamous one, including an after the fact conclusion on management's business judgement. " As long as substantial differences exist in the tax rates imposed upon the corporation on the one hand and upon the individual on the other, however there will continue to be a need for such tax "as a barrier to...tax avoidance" (Homer L. Elliot, 2019).
- Doernberg R.L, (1981), The accumulated earnings tax: the relationship between earnings and profits and accumulated taxable income in a redemption transaction, Florida law review 34, p.715 Heinonline
- Elliot L.H, (2019), The accumulated earnings tax and the reasonable needs of the business: A proposal, William & Mary Law Review 34, p.2, Heinonline
- Madeo A.S, (1979), An empirical analysis of tax court decisions in accumulated earnings cases, The accounting review vol.54, nr.3, p.538 JSTOd
- Whittenburg G.E, Gill. S, Altus-Buller. M, (2017), Income tax fundamentals 2017, San Diego State University, USA
Author: Jakub Winiarski