Accumulated Earnings Tax Application and Calculation

Reasonable Needs of the Business(i.e. justification for maintaining liquid assets)

  • Working capital for one complete operating cycle(the Bardahl formula)
  • Anticipated repairs/replacements of existing assets
  • Anticipated internal financing for growth such as plant expansion, a new office building, increases in inventory, increases in accounts receivables
  • Acquisition of a business through purchase of stock or assets
  • Debt retirement
  • Investments or loans to suppliers or customers necessary to the maintenance of the corporation’s business

Unacceptable Grounds for Accumulation of Excess Liquid Assets

  • Loans to shareholders and expenditures for their personal benefit
  • Loans to relatives or friends of shareholders or to others who have no reasonable connection with the business
  • Loans to commonly controlled corporations(brother/sister corporation)
  • Investments that are not related to the business
  • Accumulations of funds to provide against unrealistic hazards
  • Accumulations of funds to redeem shareholders

How to Calculate the Accumulated Earnings Tax Penalty

  • It’s the lesser of:
    • Accumulated taxable income(adjusted to bring this number more in line with the ability of the corporation to pay dividends) less “reasonable needs of the corporation”- which is never less than $250,000
    • Liquid assets less “reasonable needs of the corporation”
    • Less: Dividends paid
    • Times: 15% (dividends tax rate-which will likely increase next year)
    • There must be a tax avoidance motive but if there is an unreasonable accumulation of liquid assets, such accumulation will be deemed evidence that there was a tax avoidance motive.

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