@081 CHAP 8

             ÚÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄ¿
             ³      ACCUMULATED EARNINGS TAX      ³
             ÀÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÙ

@IF119xx]NOTE FOR @NAME:
@IF119xx]
@IF119xx](The following discussion of the accumulated earnings tax is
@IF119xx]not particularly relevant for your business, which is a
@IF119xx]@ENTITY, and not a C corporation.)
@IF119xx]
@IF110xx](NOTE:  Because your firm is organized as a C corporation, it
@IF110xx]is possible that the accumulated earnings tax penalty des-
@IF110xx]cribed below could apply to @NAME.
@IF110xx]
@IF110xx]If so, you may want to consider electing S corporation stat-
@IF110xx]us, in order to eliminate any further exposure to this "pen-
@IF110xx]alty tax" in the future.)
@IF110xx]
Because (federal) corporate income tax rates begin at only
15% on the first $50,000 of taxable income of a C corpora-
tion, and only $22,250 on the first $100,000 of taxable
income (22.25%), it is tempting to accumulate as much in-
come in the corporation as possible at those low tax rates,
rather than pay out dividends (or even deductible salaries
to stockholders), which may be taxable at 31% or even some-
what higher rates to the owners.  The tax law has long pro-
vided for an ACCUMULATED EARNINGS TAX on any such income
accumulations that are considered to be excessive.

Corporations are generally allowed to accumulate up to
$250,000 of undistributed earnings (only $150,000 for cer-
tain professional service corporations) without any ques-
tions from the IRS.  Above this safe harbor, however, a
corporation must be able to justify the accumulation based
on the "reasonable business needs" of the company.  If not
able to justify excessive accumulations, the corporation
becomes potentially subject to the accumulated earnings
penalty tax, which is 28% of the amount determined to be
"excessive accumulations."

Thus, while there are definite benefits to accumulating
some annual profits in a C corporation, one needs to be
wary of the accumulated earnings penalty tax, unless you
are able to demonstrate that the corporation is retaining
the capital because it needs to plow it back into the busi-
ness for working capital, expansion, etc.

The possibility of being hit by the accumulated earnings
penalty tax is one of the disadvantages of operating as a C
corporation.  This is one less tax to worry about if you
remain unincorporated, or elect to operate your corporation
under Subchapter S (as an "S corporation").

        ÚÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄ¿
        ³ WAYS OF AVOIDING THE ACCUMULATED EARNINGS TAX ³
        ÀÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÙ

While accumulating earnings in a C corporation can be a
worthwhile tax planning maneuver, you may find after a num-
ber of years that you have accumulated several hundred thou-
sand dollars in the corporation, and that cash is coming
out of the corporation's ears.  In that case, the corpora-
tion will become an inviting target for an overeager IRS
auditor who wants to slap the corporation with a large ac-
cumulated earnings penalty tax.  Here are a few strategies
for avoiding (or getting out of) this bind:

   . Elect S corporation status, where this is feasible,
     as a last resort. S corporations are not subject to
     the accumulated earnings tax.

   . Reduce excess liquidity (too much cash, stocks and
     bonds, etc.) in the corporation by plowing profits
     back into the business, buying more equipment, facil-
     ities.  Consider having the corporation buy real
     estate that it is currently leasing from a landlord
     or prepay some of the debts of the corporation.  Or,
     if buying out another shareholder, let the corpora-
     tion redeem his or her stock, rather than buy it
     yourself as an individual.  Such a redemption will
     reduce the corporation's excess liquidity AND (in
     part) its accumulated earnings.

   . Set up a reserve to redeem stock of a shareholder
     (who has died) in order to provide cash for the in-
     dividual's estate to pay death taxes, funeral expen-
     ses and other estate expenses.  This reserve, if
     properly documented, is like a debt that is allowed
     as a reduction of the corporation's accumulated
     earnings, in determining the amount of excessive
     accumulated earnings.

   . Create a fund to allow for a bona fide plan to re-
     place facilities or to expand the business, includ-
     ing an acquisition of another business.  Be sure to
     thoroughly document these plans in your corporate
     minutes.

   . Set up a reasonable reserve fund, if in manufactur-
     ing, to pay potential uninsured product liability
     claims.  This reserve is not deductible in computing
     income tax, but can be taken into account for pur-
     poses of the accumulated earnings tax.

   . Accumulate funds to retire indebtedness created in
     connection with the business of the corporation.

   . Establish a "defined benefit pension plan" with an
     initial "past service liability" that must be funded
     over a period of years.

@CODE: LS
In @STATE, any accumulated earnings are confiscated
by the senior members of the Party.

@CODE:OF