A Planning Opportunity Revealed from the 2017 Tax Act
AC-Corporation that accumulates earnings-- instead of distributing them out as dividends to shareholders-- is subject to an excise tax on the retained earnings above $250,000, unless an exception applies.
One such exception is when a corporation uses accumulated earnings to fund life insurance for a business continuation plan.
The 2017 Tax Act lowered the corporate tax rate to a flat 21%, which is much lower than the top personal tax rate of 37% for many business owners and executives.
Therefore, with the lower corporate rate, C-Corporations can now accomplish their business continuation objectives by using the company’s accumulated earnings (AE) to fund these plans.
With limited exceptions, IRC§ 531 requires that the accumulated earnings be subject to a 20% excise tax when the amount of AE is above $250,000. The exceptions are generally related to the reasonable needs of the business.1
The IRS considers the following as reasonable needs of a business:
§ Specific, definite, and feasible plans for using AE in the business.
§ Business expansion, constructing new facilities, and investing in newer equipment.
§ Accumulating an amount necessary to:
1 If the company is structured as a personal service corporation (PSC), the amount of earnings that may be accumulated inside the company is $150,000 before the tax applies. S-Corporations are not subject to the tax since they are pass-through entities.
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