Definition:
Accumulated Earnings Tax (AET) is a federal tax imposed on corporations that accumulate earnings beyond a reasonable need for business purposes. It’s designed to discourage corporations from hoarding profits instead of distributing them to shareholders as dividends.
Key points about AET:
- Purpose: To prevent corporations from avoiding income tax by accumulating earnings.
- Tax rate: The AET is a flat tax rate applied to the accumulated earnings that exceed the reasonable needs of the business.
- Reasonable needs: The IRS determines what constitutes a reasonable need for business purposes, considering factors such as the company’s growth plans, investment needs, and financial condition.
- Avoidance: Corporations can avoid AET by distributing profits to shareholders as dividends or by justifying the need for retained earnings.
Why is AET important?
- Tax revenue: AET generates revenue for the federal government.
- Fairness: It helps to ensure that corporations pay their fair share of taxes.
- Economic activity: By encouraging corporations to distribute profits, AET can stimulate economic activity through dividend payments to shareholders.
It’s important for corporations to be aware of AET and to plan accordingly to avoid penalties. If a corporation is at risk of exceeding the reasonable needs for business purposes, it should consider distributing profits to shareholders or justifying the need for retained earnings.
