Question

24. Explain the purpose of the accumulated-earnings tax, when it is imposed, and the rate at which it is imposed. Include the Internal Revenue Code Section

Answer 1

Purpose of the Accumulated Tax :

The purpose of the accumulated earnings tax is to discourage the accumulation of earnings if the reason for such accumulation is to allow shareholders to avoid paying taxes on such earnings by not paying them dividends.

accumulated tax imposed:

The accumulated earnings tax is atax imposed by the federal government on companies with retained earnings deemed to be unreasonable and in excess of what is considered ordinary. Essentially, this tax encourages companies to issue dividends, rather than retain the earnings.

accumulated tax rate at it is imposed:

an accumulated earnings tax of 20% is applied on retained earnings that exceed the exemption amount. The government imposed this tax to deter investors from negatively influencing a company's decision to pay dividends, since investors or shareholders would avoid paying tax on dividends if the company does not distribute the earnings in the first place. The premise behind this tax is that companies that retain earnings typically experience higher stock price appreciation. Although this is beneficial to stockholders as capital gains taxes are lower than dividend taxes, it is detrimental to the government because tax revenues decrease. By adding an extra tax upon a firm's retained earnings, the taxman will either collect more taxes from the company or persuade them to issue dividends, thereby, allowing the government to collect from the stockholders.

accumulated earning tax- internal revenue code section:

(a)General rule

The accumulated earnings tax imposed by section 531 shall apply to every corporation (other than those described in subsection (b)) formed or availed of for the purpose of avoiding the income tax with respect to its shareholders or the shareholders of any other corporation, by permitting earnings and profits to accumulate instead of being divided or distributed.

(b)ExceptionsThe accumulated earnings tax imposed by section 531 shall not apply to—

(1)a personal holding company (as defined in section 542),

(2)a corporation exempt from tax under subchapter F (section 501 and following), or

(3)a passive foreign investment company (as defined in section 1297).