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Understanding Accumulated Earnings Tax (AET) and Its Implications for Closely Held Corporations

The Accumulated Earnings Tax (AET) is a penalty tax imposed on corporations that retain profits beyond their reasonable business needs to avoid dividend distribution to shareholders. It is taxed at the highest individual rate of 15% on dividends. To avoid this tax, shareholders must demonstrate a tax-avoidance motive. Common indicators of tax avoidance include unnecessary loans to shareholders or investments unrelated to business. Corporations can reduce AET liability by paying dividends or through certain adjustments, but compliance with regulations is crucial to avoid complications.

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Understanding Accumulated Earnings Tax (AET) and Its Implications for Closely Held Corporations

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  1. Definition of AET • Penalty tax to compel corps to distribute profits not needed for conduct of its business • Tax at highest individual tax rate on dividends (15%) • S/h must have tax-avoidance motive to avoid receipt of dividends • Usually applies to closely held corps

  2. Evidence of Tax Avoidance Large liquid asset build up (+ high E&P) Loans to shareholders Corporate funds spent for personal benefit of shareholders Loans to a brother/sister corp Investments unrelated to corp’s business Protection against unrealistic hazards

  3. Evidence of Reasonable Needs Expansion or replacement of facilities Acquisition of a business enterprise Debt retirement Working capital - Bardahl formula Loans to suppliers or customers Product liability losses Stock redemptions Business contingencies

  4. AET Liability(1 of 2) 15% of AE taxable income Issue usually raised one or more years after tax year in question Once determined, liability cannot be reduced by deficiency dividend Dividends actually paid during tax year reduce AETI AEC available but subject to phaseout

  5. AET Liability(2 of 2) Taxable income + Positive adjustments DRD, NOL, charitable contrib. c/o, capital loss carryover - Negative adjustments Accrued US/foreign inc. taxes, excess net cap. loss, charitable contrib., after-tax cap. gain - Dividends-paid deduction - Accumulated earnings credit (See Ex C:5-21) = Accumulated taxable income

  6. Compliance and Procedural Considerations • Accumulated earnings tax • No schedule or return

  7. Problem C:5-58

  8. Problem C:5-58

  9. Problem C:5-58

  10. Problem C:5-62a

  11. Problem C:5-62a

  12. Problem C:5-62b

  13. Problem C:5-60

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