An analysis of the federal income tax concept of earnings and profits as compared to the financial accounting concept of retained earnings

This dissertation studies the relationship between earnings and profits and retained earnings and the feasibility of reconciliation of the two accounts by outside corporate investors. Deductive conclusions are based on data derived from publicly available literature, seventeen earnings and profits studies prepared by selected certified public accounting firms, and an interview with a representative of the Internal Revenue Service. Ninety-two potential transactional differences between earnings and profits and retained earnings are analyzed and classified as resulting in no differences, timing differences, or permanent differences between the accounts. Corroborative inferences are drawn from the data developed from the seventeen earnings and profits studies and from the interview with the representative of the Internal Revenue Service. This dissertation concludes that earnings and profits and retained earnings (1) only in extremely rare situations are equal in amount and (2) cannot be reconciled using publicly available information. In addition, the inference is drawn that retained earnings is not a valid surrogate for earnings and profits. The consequences of these conclusions and inference are that outside investors are not receiving useful information about earnings and profits and cannot generate that information. The dissertation recommends that the United States Congress define earnings and profits, that the Internal Revenue Service require calculation of the account by all corporate taxpayers on an annual basis, and that the Financial Accounting Standards Board consider the issue of reconciliation of earnings and profits and retained earnings. In addition, recommendations for future research in this area are offered