Watch out for accumulated earnings tax

Corporations have an incentive to retain earnings, rather than distribute them to shareholders, to avoid, or at least delay, double taxation. The accumulated earnings tax (AET) is designed to discourage that practice. If the IRS concludes that a corporation is retaining unreasonably high levels of earnings, then it may assess the AET — a 20% penalty tax on the corporation’s accumulated taxable income.

To determine a corporation’s accumulated taxable income, a CPA takes the corporation’s taxable income, subtracts dividends paid and an accumulated earnings credit, and makes certain other adjustments. The accumulated earnings credit allows corporations to accumulate up to $250,000 in earnings ($150,000 for certain service corporations) without fear of triggering the AET.

If a corporation has accumulated taxable income, the IRS may impose AET if it finds that the corporation is retaining, rather than distributing, earnings beyond the “reasonable needs of the business.” To avoid the tax, a corporation should be prepared to explain and document its need to retain earnings for working capital, business expansion, equipment purchases or other purposes.

State income tax liability for remote sellers?

In recent years, many states have expanded their imposition of sales tax on out-of-state e-commerce businesses and other remote sellers. But what about state income tax? For decades, Public Law (P.L.) 86-272 has prohibited states from imposing their income tax on out-of-state businesses whose only activities in the state are the solicitation of orders for the sale of tangible personal property, provided those orders are accepted and filled from outside the state.

Recently, however, the Multistate Tax Commission (MTC) issued revised guidance that may prompt states to expand the reach of their income tax. The guidance lists several activities that the MTC believes are unprotected by P.L. 86-272 and, therefore, may support taxation of remote sellers.

A few examples: 1) regularly providing post-sale assistance to in-state customers via electronic chat or email that customers initiate by clicking on a website icon, 2) placing cookies on in-state customers’ computers or other devices to gather search information that will be used to adjust production schedules and inventory amounts, develop new products, or identify new items to offer for sale, and 3) offering and selling extended warranty plans via the company’s website to in-state customers who purchase its products.

Keep in mind that the MTC’s new guidance will have an impact only if states adopt new laws that expand their power to tax remote sellers. Additionally, those laws will need to survive the inevitable challenges under P.L. 86-272.

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