Who says you can’t have “too much” money? The Internal Revenue Code imposes a little-known tax for accumulating too much in the way of earnings in a company’s coffers. However, you can avoid this so-called “accumulated earnings tax” if you keep a close watch on your cash flow during the year,

The accumulated earnings tax must be paid in addition to the regular corporate income tax. Despite recent threats by Congress to raise the ante, this penalty tax remains at the 20% rate.

Background: The accumulated earnings tax is intended to discourage hoarding money within a company. It applies to “accumulated taxable income,” defined as the company’s taxable income (with certain adjustments) minus the dividends-paid deduction and an the accumulated earnings credit. The minimum tax credit for this purpose is $250,000, or $150,000 for personal service corporations. Note: These amounts aren’t indexed for inflation.

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In other words, if you can keep the cash in your company below the $250,000 or $150,000 threshold for the year, you’re home free. You completely avoid the tax.

Furthermore, if you exceed the minimum credit amount, there’s a fallback position. No penalty is imposed on amounts accumulated for a “reasonable business need.” To qualify under this safe harbor rule, you must show that you have a definite plan in place for using the money in the applicable tax year.

What’s a reasonable business need? Previously, the following reasons have qualified under this umbrella.

Retirement of debt
Expansion of the business or replacement of the plant
Acquisition of a business through purchase of stock or assets
Accumulation of working capital for the business (e.g., to purchase inventory)
Investments or loans to suppliers or customers necessary for maintenance of the business

However, these reasons cited by business owners have not passed muster in the past.

Loans to shareholders and expenditures for their personal benefit
Loans to friends or relatives of shareholders
Investments unrelated to the business
Accumulations to provide against unreasonable hazards

Is that all there is to it? Not quite. Other factors may come into play. For instance, if you own a business in a volatile industry with wide swings in earnings, you might have a better case for accumulating cash than other businesses operating on an even keel. Similarly, if your firm is in a highly competitive field based on cutting-edge technology, you may have a greater need for keeping additional funds on hand.

Take these steps to strengthen your case for accumulating more cash.

1. Adopt a consistent dividend-paying policy.

2. Obtain expert opinions to support anticipated replacement costs.

3. Do the same for accumulations to safeguard against business hazards.

4. Move expansion plans into the blueprint stage as soon as possible.

5. Keep detailed records of valid business reasons for accumulating earnings in the corporate minutes. This is the best proof your company can have for justifying any excess amounts.

Finally, if you’re unsure of your position, pay out enough dividends to stay below the $250,000 or $150,000 threshold. That will do the trick.