The accumulated earnings tax (AET) is imposed by Internal Revenue Code (IRC) §531, on C corporations “formed or availed of” for the purpose of avoiding the imposition of income tax on their shareholders, by permitting earnings and profits to be accumulated instead of being distributed. As a practical matter, the tax is collected only when asserted by the Internal Revenue Service on examination, rather than through self-assessment by taxpayers, and even then is not frequently encountered on audit in the experience of the authors. This may be in part because of the obvious economic desirability of distributions, particularly at the relatively low rates applicable since 2001, and in part because of the availability of pass-through entities such as partnerships and S corporations not subject to the AET. Accordingly, conducting business through a C corporation and retaining earnings at the corporate level beyond the needs of the business seems unlikely to be a compelling tax avoidance strategy.
Nonetheless, the AET remains part of the Internal Revenue Code, and developments over the past decade, including increases in the highest rate of federal tax imposed with respect to qualified dividend income (from 15 percent to 20 percent) and the 3.8 percent tax on “net investment income,” may cause further consideration to be given to deferral of distributions. Perhaps coincidentally, the IRS Chief Counsel recently issued a memorandum concluding that the AET may apply to a corporation that lacks ready access to cash or other liquid assets for distribution. The structure of the AET and Chief Counsel Advice 201653017 (Dec. 30, 2016) are discussed below.
