Page 177 - TaxAdviser_2022

tax (see Alta Peruvian Lodge Ltd., No.
Corporations & Shareholders 22821-21, petition filed Sept. 15, 2021,
and Ban & Bhat Enterprise Inc., No. A nondividend
A resurgence of the 27899-21, petition filed Oct. 22, 2021). payment by a
accumulated earnings tax? The accumulated earnings tax can be
The accumulated earnings tax is a 20% a trap for the unwary, especially for corporation out of
its surplus earnings
penalty that is imposed when a corpora- profitable companies unaccustomed to
tion retains earnings beyond the reason- documenting how they will use their may be viewed by
able needs of its business (i.e., instead earnings, forming policies for pay-
of paying dividends) with the purpose ing dividends, or outlining how their the IRS as evidence
of a purpose to avoid
of avoiding shareholder-level tax (see investments relate to their business.
Sec. 531). In periods where corporate Companies should understand how to
tax rates were significantly lower than protect themselves against a potential shareholder-level
income tax.
individual tax rates, an obvious incentive IRS enforcement action.
existed for corporations to allow earn-
ings to accumulate instead of paying Evidence of a purpose to avoid
dividends to their shareholders. While shareholder income tax
that particular disparity no longer ex- Generally, the accumulated earnings tax nonpayment (or insufficient pay-
ists, the law known as the Tax Cuts and is imposed on any corporation formed ment) of dividends;
Jobs Act of 2017, P.L. 115-97, lowered or availed of for the purpose of avoiding ■ The investment by the corporation of
corporate-level tax rates significantly shareholder-level income tax by permit- undistributed earnings in investments
from 35% to 21%. As a result, the IRS ting earnings to accumulate instead of not related to its business; or
could view this decrease in corporate- being distributed to shareholders (see ■ A personal loan by the corporation
level tax rates as an incentive for com- Sec. 532(a)). Whether a purpose exists to a shareholder or expenditures
panies to retain their earnings (or place to avoid income tax on the sharehold- by the corporation for the personal
them in unrelated investments) instead ers is a subjective determination based benefit of a shareholder (see Regs.
of paying dividends to shareholders. upon all of the facts and circumstances. Sec. 1.533-1(a)(2)).
Recent petitions before the U.S. Factors that could indicate evidence of The fact that a corporation accumu-
Tax Court, as well as the authors’ own a purpose to avoid income tax include, lates earnings beyond the reasonable
observations, suggest the IRS is indeed without limitation, the following: needs of its business is determinative of
stepping up its enforcement efforts with ■ An unreasonable accumulation of a purpose to avoid shareholder income
respect to the accumulated earnings earnings by the corporation and tax unless the corporation proves to the
contrary by a preponderance of the evi-
dence (see Regs. Sec. 1.533-1(a)(1)).
The unreasonable accumulation
of earnings and nonpayment of
dividends
A corporation’s accumulation of earnings
must not exceed an amount appropriate
for the reasonably anticipated future
needs of its business; otherwise, this may
indicate a purpose to avoid shareholder
income tax. To demonstrate that its ac-
cumulation of earnings is for the needs
of the business, the corporation must
PHOTO BY ZENTILIA/ISTOCK have specific, definite, and feasible plans
for how it intends to utilize its earnings
in business operations (see Regs. Sec.
1.537-1(b)(1)). Thus, a corporation must
show that it intends to use its earnings

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