Don't Be Fooled by The C Corp. Fairy Tales - Palma Financial

Many people love the 21 percent corporate tax rate, and they are keeping more money inside their corporations, and maybe you too…

You have to beware of the accumulated earnings tax. You likely don’t have the proper documentation to avoid it. And it’s expensive.

The accumulated earnings tax is a 20 percent penalty tax assessed by the IRS on your company’s corporate tax return.

The penalty is triggered after an IRS audit for not paying dividends.

Keep in mind that a corporation cannot accumulate earnings exceeding $250,000 or $150,000 for a personal service corporation without demonstrating an economic need.

QUESTION: Why do you need more than $250,000 in accumulated earnings ($150,000 if you are a personal service corporation)?

If you can answer this, you have no problem.

Be ready, and do not wait until being audited.

QUESTION: Why should you keep the earnings in the corporation?

  • To pay for the death taxes, funeral, and administrative expenses.
  • To shut down operations, sell the business, and otherwise deal with corporate needs caused by the owner’s (shareholder’s) death.

The IRS provides a list of reasons for accumulating C corporation earnings:

  • Provide for bona fide expansion of business or replacement of plant
  • Acquire a business
  • Retire indebtedness of the corporation
  • And more…

The IRS lists the following as likely unreasonable reasons for accumulating the earnings:

  • Making loans to the shareholders
  • Making loans to other corporations and business entities owned by the shareholders
  • Investing in properties unrelated to the corporation’s activities
  • Investing in securities unrelated to the corporation’s activities
  • Citing needs for unrealistic contingencies and hazards.

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