Looking to Benchmark Pay?
See our salary, cost-of-living, and executive compensation data in action.
Reasonable business needs
If a corporation has its funds invested in assets essential to the needs of the business, the IRS will have a hard time imposing the AET.
The amount of accumulated earnings is not important. It is how the accumulated earnings are used that matters.
Reasonable needs must be:
- specific
- definite
- feasible
Indefinite plans or those mentioned briefly will not be accepted. IRS regulations indicate some of the grounds that may be considered legitimate needs of the business.
Here are some reasons the IRS might approve accumulating earnings:
- Earnings may be allowed to accumulate to provide for bona fide expansion of the business enterprise or replacement of plant and facilities, as well as to acquire a business enterprise through purchasing stock as assets.
- Providing for the retirement of bona fide indebtedness created in connection with the trade or business (i.e., the establishment of a sinking fund for the purpose of retiring bonds issued by the corporation in accordance with contract obligations incurred on issue).
- Providing necessary working capital for the business (e.g., procurement of inventories).
- Providing for investment or loans to suppliers or customers (if necessary to maintain the business of the corporation).
- Funds may be retained for self-insurance and realistic business contingencies (e.g., lawsuit, patent infringement).
- Accumulations to maintain a competitive position and to carry key-employee life insurance policies are justifiable reasons.
Here are some reasons the IRS may not approve of:
- Loans to shareholders.
- Loans to brother-sister corporations.
- Unrealistic contingencies.
- Investments in assets unrelated to the business.
Memory Jogger
Which of the following statements is true of the Accumulated Earnings Tax (AET)?
Looking to Benchmark Pay?
See our salary, cost-of-living, and executive compensation data in action.