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 Put Away Cash 
 for "Reasonable" Needs

A corporation that accumulates more than $250,000 in retained earnings could be slapped with an expensive penalty tax by the IRS. Fortunately, you can escape the "accumulated earnings tax" with some shrewd moves.

You're allowed to retain cash for legitimate, reasonable future business needs. How does the tax law define reasonable? Thereís no exact definition but the IRS says that any plans for excess cash must be "specific, definite and feasible." Otherwise, your firm

 In general, C corporations canít stockpile more than $250,000 ($150,000 for personal service corporations) unless the money is being retained for the "reasonable needs of the business."

could face the accumulated earnings tax in addition to its regular corporate tax. The penalty is 15 percent for 2005.

The reason for the penalty tax is to keep business owners from keeping earnings in their corporations so they don't have to pay taxes on the dividend distributions.

 The good news

Corporations frequently fight the IRS on this issue ó and win. For example, some businesses successfully put money aside to modernize their facilities or build new offices.

In one case, a Texas corporation convinced the Tax Court that it needed excess earnings for several reasons, including renovation, expansion, and the possible redemption of shareholder stock.

The firm wisely documented discussions of its plans and the court noted that officers exercised "prudent business judgment." (Knight Furniture Co., Inc. TC Memo 2001-19)

The key to beating the IRS is to establish a plan based on the reasonable, legitimate future needs of your business. Make sure to discuss the issue with your tax adviser and document the plans in your corporate minutes. Ronald J. Cappuccio, J.D., LL.M.(Tax) 1800 Chapel Avenue West Suite 128 Cherry Hill, NJ 08002 Phone:(856) 665-2121      Fax: (856) 665-9005 Email:

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