MASTERING MANAGEMENTPlan Now to
Escape the Corporate Retained Earnings Penalty
CHANTILLY, VA - A corporation that accumulates more than $250,000 in
retained earnings could be slapped with a penalty "accumulated
earnings tax" by the Internal Revenue Service (IRS), unless the
retained earnings are handled very carefully. In general, the IRS limits
corporations to stockpiling no more than $250,000 ($150,000 for personal
service corporations) unless the money is being clearly retained for the
"legitimate, reasonable future business needs of the business."
The reason for the penalty tax is to keep business owners from keeping
earnings in their corporations so they don't have to pay taxes on the
dividend distributions. How does the tax law define
"reasonable"? There's no exact definition, but the IRS says that
any plans for excess cash must be "specific, definite and
feasible." Otherwise, your firm could face the accumulated earnings
tax in addition to its regular corporate tax. The penalty is 15 percent.
The good news is that C corporations frequently fight the IRS on this
issue - and win. For example, some businesses successfully put money aside
to modernize their facilities or build new offices. In one case, a Texas
corporation convinced the tax court that it needed excess earnings for
several reasons, including renovation, expansion, and the possible
redemption of shareholder stock. The firm wisely documented discussions of
its plans and the court noted that officers exercised "prudent
business judgment." (Knight Furniture Co., Inc. TC Memo 2001-19)
The key to beating the IRS is to establish a plan based on the
reasonable, legitimate future needs of your business. Make sure to discuss
the issue with your tax adviser, and document the plans in your corporate
minutes.
(Source: Automotive
Parts Rebuilders Association)
