Accumulated Earnings Tax

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DEFINITION of 'Accumulated Earnings Tax'

A tax imposed by the federal government upon companies with retained earnings deemed to be unreasonable and in excess of what is considered ordinary.

BREAKING DOWN 'Accumulated Earnings Tax'

The federal government produced this tax to deter investors from negatively influencing a company's decision to pay dividends. Essentially, this tax persuades companies to issue dividends, rather than retaining the earnings.

The premise behind this tax is that companies that retain earnings typically experience higher stock price appreciation. Although this is beneficial to stockholders, as capital gains taxes are lower than dividend taxes, it is detrimental to the government because tax revenues decrease. By adding an extra tax upon a firm's retained earnings, the taxman will either collect more taxes from the company or persuade them to issue dividends, thereby allowing the government to collect from the stockholders.

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