What is the accumulated earnings tax?

The accumulated earnings tax applies to corporations that retain earnings beyond a certain threshold instead of distributing them as dividends to shareholders. This tax aims to prevent corporations from accumulating earnings to avoid taxation at the individual level, as shareholders typically face taxes on dividends received. When a corporation holds onto its earnings and does not distribute sufficient dividends, it might be perceived as an attempt to evade taxes by retaining income.

The threshold is defined by the Internal Revenue Code, and if the accumulated earnings exceed this limit without a valid business reason, the IRS may impose this additional tax on the excess amount.

The focus of the accumulated earnings tax is on the retention of profits rather than discouraging profit generation or providing incentives for reinvestment. Thus, it serves as a means to ensure that corporations distribute earnings in a manner that aligns with tax obligations and shareholder interests.