What Is Accumulated Earnings and Profits (E&P)?
Accumulated earnings and profits (E&P) is an accounting term applicable to stockholders of corporations. Accumulated earnings and profits are a company's net profits after paying dividends to the stockholders, serving as a measure of the economic ability of a corporation to pay such cash distributions.
- Accumulated earnings and profits (E&P) are net profits a company has available after paying dividends.
- This figure is calculated as E&P at the beginning of the year plus current E&P minus distributions to shareholders during the current period.
- Retained earnings are technically different from accumulated E&P because E&P is a determinant in a corporation's ability to fund distributions.
How Accumulated Earnings and Profits (E&P) Works
End-of-year accumulated earnings and profits are the sum of beginning-of-year E&P and current period E&P less distributions to shareholders during the period. Income and losses are part of a period's E&P, but certain items—recognized for financial accounting purposes but not for income tax reporting purposes—are subject to adjustment.
Since E&P is used as a metric for the capacity of a firm to pay distributions, items such as tax-exempt income or nondeductible expenses, which factor into income tax reporting, must be added back or subtracted from the E&P account.
Calculating E&P each year is painstaking work for tax departments within a company, but it is very important to keep records current because they come into play for many corporate transactions. For example, a C corporation conversion to a real estate investment trust (REIT) requires a thorough accounting analysis of accumulated E&P before it is allowed to proceed.
Most corporations, specifically those that are C corps, must maintain E&P accounts to determine necessary tax treatment. They don’t have to report E&P but they must know the E&P amount for determining the tax treatment of a transaction. With that said, it’s much easier to maintain the accumulated E&P balance versus preparing the calculation after several years.
The tax laws do not outline how to calculate E&P and the process isn’t necessarily simple. The E&P for any year starts with the adjustable taxable income for that year. Nearly all transactions affect a company’s E&P. Certain actions can affect E&P as well, such as mergers.
Other sources of income beyond taxable income can boost E&P, such as tax-exempt income and installment sales. Items reducing E&P include cash expenses that are paid but possibly not taxable, such as charitable contributions and capital loss carryforwards.
Accumulated E&P vs. Retained Earnings
Even though they may seem synonymous, technically they are different primarily because E&P is determinant in a corporation's ability to fund distributions. A company can lower the amount of its retained earnings via stock distributions or the establishment of a contingency reserve, but they will not negatively impact the company's aforementioned capacity to pay dividends to shareholders.