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Accumulated earnings tax advice - http://en.allexperts.com/q/Tax-Law-Questions-932/accumulated-earnings-tax-potential-1.htm
- Make sure the corporation has a plan for use of the money it is retaining.
Additional Tax Problems from Operating as a C Corporation
Accumulated Earnings Tax
A corporation that takes advantage of the initial lower corporate tax brackets for taxable incomes under $100,000 and accumulates its income, may run afoul of the accumulated earnings tax. After a corporation accumulates $250,000 ($175,000 for personal service corporations), the corporation must affirmatively justify the reasonable business need for its accumulated earnings. The calculations involved are extremely complex and the corporation will probably needs to retain all its tax returns, corporate minutes and records relating to all purchases of plant, office buildings and equipment. The corporation's accountant may have to reconstruct the corporation's entire history of its earnings and profits and an expert witness testimony may be necessary to justify the amount of retained earnings.
The tax on a corporation that accumulates its income beyond the reasonable needs of its business is now 39.6% (the highest individual tax rate) on its "accumulated taxable income." Accumulated taxable income is, generally, the corporation's taxable income, less the federal income taxes paid on that income. For instance, assume a corporation had unreasonably accumulated its earnings, rather than pay them out to its shareholders. In the current year, the corporation, which had $138,000 in taxable income and paid a corporate tax of $38,000, would have accumulated taxable income of $100,000 and would be subject to an accumulated earnings tax of $39,600.
Personal Holding Company Tax
A personal holding company tax may be imposed on corporations that are controlled by a limited number of shareholders and which derive a larger percentage of the income from "passive income" sources such as dividends, interest, rents, royalties, compensation for use of corporate property by shareholders and personal service contracts. If the personal holding company applies, then the tax is 39.6% of the undistributed personal holding company income. Therefore, a "C" corporation that attempts to take advantage of the lower tax brackets and whose income is mostly from passive sources, may be subject to the personal holding company tax.