Corporations frequently want or need to retain some of their profits at the end of the year. These funds can be used for a wide range of business activities such as expansion, development, or other purposes related to growth in the business. If the corporation does retain some of its profits, the corporation will be liable for taxes on that money at the appropriate corporate income tax rate. A corporation’s owners can save money by retaining a portion of corporate profits in the company because the initial corporate income tax rates are lower than most owners’ marginal income tax rates for the same amount of income. In contrast, owners of sole proprietorships, as well as partnerships and LLCs, are taxed on all business profits at their individual income tax rates, whether they take the profits out of the business or not.
The IRS permits corporations to retain a limited amount of profits within the corporation. Most corporations can legally retain up to $250,000 at any one time in the corporation without facing negative tax consequences. There is an exception for some professional corporations that may not retain more than $150,000.