Retained earnings tax is an additional tax paid by corporations that choose to retain earnings instead of paying dividends, calculated in addition to regular corporate income tax. The tax encourages dividends and minimizes tax loss for the government.
Retained earnings tax is an additional business tax paid by corporations that choose to retain retained earnings rather than pay earnings in the form of dividends to investors. As an income tax that will be diverted to pay off outstanding debt or to invest some aspect of the company’s operation, retained income taxes are calculated in addition to regular corporate income taxes. However, it is important to remember that the amount of retained earnings can affect the total amount of income tax due in any given quarter.
The reason behind the idea of paying a retained earnings tax has to do with the anticipated impact of the retained earnings report on the shares issued by the corporation. It should be remembered that since retained earnings that are reinvested in the company are treated as capital gains rather than dividends, the government would not receive as much in tax revenue. The implementation and collection of the retained earnings tax manages to provide a bit more tax revenue while making reinvesting the earnings back into the business a viable option.
However, in some cases the retained earnings tax may be enough to discourage reinvesting the funds in some part of the operation. One possible scenario is that investors pressure the company to reinvest a large amount of retained earnings in some aspect of the business, as a way to avoid the need for investors to pay taxes on dividends. To this end, there is the potential for the government to step in if an excessive amount of retained earnings appears to be constantly being redirected into the business, rather than being used for dividends on a recurring basis.
A second scenario may have to do with generating a small amount of retained earnings. For companies that make a very small amount of retained earnings in each financial period, the bottom line may dictate that the company issue the dividends and thereby eliminate having to pay the additional retained earnings tax otherwise charged. would apply to the period.
The retained earnings tax serves the dual purpose of encouraging corporations to pay dividends, as well as minimizing the tax loss the government experiences when retained earnings are redirected to the corporation. The result of this type of tax is that investors still receive reasonable dividends, companies occasionally have a windfall to invest back in the business, and the federal government still receives its fair share of taxes.
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