The Sneaky 20% Accumulated Earnings Tax on Your Profits
If your business is successful, this could cost you another 20% (maybe more) of your profits. This article relates to profitable businesses that have accumulated some savings.
This Accumulated Earnings Tax (“AET”) is usually discovered in IRS tax audits. Be aware that the IRS has added hundreds of new auditors whose job is to find and collect this tax from profitable businesses. However, very few accountants ever discuss the AET. If your business is being audited by the IRS, then this information is a “must-know”.
The Accumulated Earnings Tax (or “AET”) is a 20% tax on your business undistributed profits. This is in addition to the other taxes that your business has already paid on your profits. The tax applies to those businesses that keep those profits and money within the business. This tax was created to force companies to pay their profits out to the owners as taxable distributions.
IRS Audits: See this related video on “How to Win IRS Audits”.
This tax could even apply if you took the PPP loans, even if you were forgiven the loans. This is because the tax might still apply to your company’s undistributed profits.
PPP LOANS: See this related video on “Can IRS Tax My PPP Loan?”
Every situation is unique. There are some exceptions to this rule. To avoid this tax, you must make a fully supported, legal argument about the “reasonable needs of the business”. This would prove how your business is an exception to the rule of being charged this extra 20% accumulated earnings tax.
Also, there is an additional 20% penalty of 20% of that tax.
Note to Business Owners: When making this legal argument, you must prove your intentions for behavior that has already occurred. This is a sensitive topic because your past actions in the business could actually encourage receiving the tax, instead of avoiding it. It is wise to have a tax lawyer handle this kind of issue with the IRS. This will better help you avoid this 20% tax (AET).
Note to Tax Accountants: Be cautious about attempting to represent this issue in IRS audits. Remember that avoiding this tax requires legal argument. You must clearly prove how your client’s past actions support the reasonable needs of the business. You must apply the law to those facts. If you are the accountant, and your legal argument fails, then you get blamed for causing your client an additional 20% tax.
Advice: Always hire a competent tax lawyer to represent profitable businesses in IRS tax audits.