A C corporation that retains earnings beyond the “reasonable needs of the business” can be hit with a 20% accumulated earnings tax under § 531. The tax applies to “accumulated taxable income” as defined in § 535.
What counts as “reasonable needs”? The regulations say an accumulation is “in excess of the reasonable needs of the business if it exceeds the amount that a prudent businessman would consider appropriate for the present business purposes and for the reasonably anticipated future needs of the business.” Reg. § 1.537‑1(a). The Supreme Court has described the tax as one that “compel[s] the company to distribute any profits not needed for the conduct of its business so that, when so distributed, individual stockholders will become liable” for tax on the dividends. United States v. Donruss Co., 393 U.S. 297, 303 (1969).
During years when corporate and individual tax rates were close, the accumulated earnings tax faded in importance. But with the TCJA creating a 16‑point gap, corporations have stronger incentives to leave earnings untouched. That means the IRS may pay closer attention to whether those accumulations truly serve future business needs or are simply a tax‑avoidance device.
A classic example: a family corporation that hoards cash year after year without a specific expansion plan. The IRS may argue the money should have been paid out as dividends, and the accumulated earnings tax could apply.
This article is for general informational purposes only and is subject to change. Tax laws are complex and vary by situation. You should consult a qualified professional for advice specific to your circumstances. For questions, contact Alan Goldstein.
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