Accumulated Earnings Tax (IRC §531)
When a C corporation distributes its earnings to shareholders, the shareholders are subject to income tax on the dividends received. Since the corporation has already paid income tax on those earnings, the tax on dividends is considered to be double taxation of the same income (once at the corporation level and once at the shareholder level). This produces an incentive for closely held corporations to accumulate their earnings inside the corporation rather than distribute them to shareholders.
To counter this incentive, the law says a C corporation is not allowed to accumulate earnings beyond the amount needed for bona fide business reasons. A bona fide business reason to accumulate earnings is for possible future expansion of the business. If earnings accumulate beyond the reasonable needs of the business, and the purpose is determined to be tax avoidance, a penalty applies to the excess. For tax years prior to 2013, the penalty was 15% of the accumulated excess earnings.
New Law: The new law increases the penalty to 20% of the accumulated excess earnings for tax years beginning after December 31, 2012.
S Corporation Built-In Gains Tax [IRC §1374(d)(7)]
If a corporation has always been an S corporation, the built-in gains tax does not apply. Built-in gains tax applies if:
- A C corporation elects S corporation status after 1986,
- The combined fair market value (FMV) of the corporation’s property is greater than basis, and
- The property is sold or distributed within 10 years of the election to be taxed as an S corporation.
Built-in gains tax is 35% of the net recognized built-in gain, limited to taxable income computed as if the corporation were taxed as a C corporation. Net recognized built-in gains is the excess of gains over losses on property sold during the year that is subject to the tax. Accounts payable and accounts receivable are examples of built-in loss and built in gain property for a cash basis taxpayer.
For sales or distributions of built-in gain property during tax years 2009 and 2010, the 10-year holding period was reduced to seven years. For tax year 2011, the holding period was reduced to five years. Under prior sunset provisions, the holding period was scheduled to increase back to 10 years for sales or distributions after 2011.
New Law: The new law extends the five year holding period provision for sales occurring in 2012 and 2013. The new law also clarifies how installment sales are applied to this rule. If an S corporation sells an asset and reports the income from the sale using the installment method, the treatment of all payments received is subject to the built-in gains tax provisions applicable to the taxable year in which the sale was made.
Work Opportunity Credit (IRC §51)
A business can claim a Work Opportunity Credit equal to 40% of the first $6,000 of wages paid to new hires of one of eight targeted groups ($6,000 of wages × 40% = $2,400 maximum tax credit). These groups include members of families receiving benefits under the Temporary Assistance to Needy Families program, qualified ex-felons, designated community residents, vocational rehabilitation referrals, qualified summer youth employees, qualified food and nutrition recipients, qualified SSI recipients, and long-term family assistance recipients.
Returning Heroes and Wounded Warriors Work Opportunity Credits
A business is also allowed to claim a Work Opportunity Credit for hiring qualified veterans in the following targeted groups and up to the following amount of wages paid:
Veterans in a family receiving supplemental nutrition assistance:
$6,000 of wages × 40% = $2,400 maximum credit.
Short-term unemployed veterans:
$6,000 of wages × 40% = $2,400 maximum credit.
Service-related disabled veterans discharged from active duty within a year:
$12,000 of wages × 40% = $4,800 maximum credit.
Long-term unemployed veterans:
$14,000 × 40% = $5,600 maximum credit.
Long-term unemployed service-related disabled veterans:
$24,000 × 40% = $9,600 maximum credit.
A credit against Social Security taxes is also available to tax-exempt employers. Under prior law, the Work Opportunity Credit was scheduled to expire for workers hired after 2012 for qualified veterans and 2011 for all other workers.
New Law: The new law extends the Work Opportunity Credit for all workers who begin work for the employer prior to 2014.
Disclaimer: Electrical Distributor Consulting is not a law firm, CPA, or affiliated with the IRS. We are Electrical Distributors sharing our knowledge and experience to help improve distributors looking to go to the next step. Please seek the advice of your local professional to see how these tax code changes may affect you.