According to the Internal Revenue Service (IRS), corporations may accumulate earnings in order to expand or for other "bona fide business reasons." If such earnings accumulate beyond what the IRS consider reasonable business needs, the accumulated earnings tax kicks in. As of the time of publication, this tax is 15 percent, with interest applicable from the time of the original corporate tax return due date. A statute of limitations applies to entities involved in questionable business practices.
Determining Accumulated Earnings Tax
IRS standards treat an accumulation of less than $250,000 as within most businesses' reasonable needs. However, businesses in certain fields may only accumulate less than $150,000 in order to be considered a "reasonable need." These fields include consulting, health care, veterinary practices, accountants, law, insurance, engineering, architecture and the arts. To determine if the business has accumulated earnings and profits (E and P) beyond its needs, all corporate-owned securities purchased with its E and P should be valued not at cost but the net value if liquidated.
The IRS defines reasonable needs as feasible and specific plans for using the accumulated earnings to expand and improve the business. If there are no substantial and genuine reasons for accumulated earnings, and the business has an "unreasonable" accumulation of such earnings, the IRS considers that grounds for the corporation's need to pay the accumulated earnings tax. It cites a lack of consistent distributions to shareholders or personal loans made to shareholders as evidence of avoiding such taxation. The IRS considers corporations formed as a "mere holding or investment company" as evidence it was established as a tax shelter for shareholders.
In the United States Tax Court, certain contingencies for excessive accumulated earnings have received justification. These include lawsuits, whether real or potential; loss of a major customer leading to probable business difficulties; accumulations to safeguard against competitors, and contractual obligation liability. The court has also ruled that accumulations to provide employees with a retirement plan or fund self-insurance plans are justifiable.
Statute of Limitations
The statute of limitations depends on the status of the individual. For a transferee, or the entity or individual receiving the transferor's assets for less than complete consideration, the statute of limitations is three years. For any fiduciary institution or person, such as an accountant, the statute of limitations is no longer than one year after the tax liability arises. There is no statute of limitations for actual fraud, such as the filing of a false return.
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