Accumulated earnings tax

The accumulated earnings tax is a federal tax that penalizes a company for retaining an excessive amount of its earnings, rather than distributing them to investors via dividends. This tax is designed to force a business to shift its earnings to investors, who will then pay income taxes on the dividends received. Liability for the accumulated earnings tax is based on the following two considerations:

  • That the business has retained more profits than it needs; and
  • There is an intent to avoid taxation of profits by keeping them away from investors.

The use of loans to investors instead of dividends can be evidence of intent by corporate management to avoid investor taxation, as is a history of not issuing dividends.