TAX ON IMPROPERLY ACCUMULATED EARNINGS

TAX ON IMPROPERLY ACCUMULATED EARNINGS

As a corollary measure to the re-imposition of the tax on dividends, a ten percent (10%) tax on improperly accumulated earnings was made part of the CTRP by Congress. The tax would cancel out the benefits from retaining the income of a corporation instead of declaring dividends because the latter is subject to a 10 percent tax.

This tax applies to corporations which are formed or are used as a means to avoid the income tax by permitting earnings and profits to accumulate instead of being divided or distributed.

What are the indicators that a corporation is improperly accumulating income?

The fact that a corporation is a mere holding company or investment company is prima facie evidence of a purpose to avoid the tax upon its shareholders or members;
the fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the business is determinative of the purpose to avoid the tax upon its shareholders or members unless the corporation, by the clear preponderance of evidence, is proven to be on the contrary.

Using these indicators, the following entities are clearly exempt from the tax:

publicly-held corporations

banks and other non-bank financial intermediaries

insurance companies