New Israeli Law Imposes 2% Annual Tax on Excess Corporate Profits Starting 2026
Starting in 2026, thousands of private companies in Israel will face significant changes due to the implementation of the "Retained Earnings Law," which targets the longstanding practice of deferring personal tax by retaining profits within companies. Previously, private business owners could accumulate profits inside their companies, investing passively in real estate, bank deposits, or capital markets, thereby postponing personal dividend taxes for years. This practice led to substantial tax deferrals and prompted the government to introduce a new annual 2% tax on excess retained earnings beyond a legally defined threshold.
The law aims to encourage business owners to reinvest funds into active business operations rather than accumulate passive investments. The 2% tax is not deductible and does not offset future dividend taxes, meaning that leaving money idle in the company could result in a growing cumulative tax burden. To avoid this tax, companies must distribute dividends or meet other payout mechanisms starting in 2026, after a transitional period that ended in 2025. Dividend taxes for significant shareholders typically range from 30% to 35%, including surtaxes.
To protect operational liquidity, the law includes a "safety cushion" that exempts from the tax the higher of three criteria: 750,000 shekels, the company’s regular operating expenses, or the value of active business assets. Notably, passive assets such as investment portfolios, securities, deposits, and non-operational real estate are excluded from this calculation, potentially increasing taxable retained earnings.
Service companies heavily reliant on the personal work of controlling shareholders, such as doctors, consultants, lawyers, and other professionals, face additional rules that may tax some retained earnings as personal income at the highest marginal rates, further reducing the previous tax advantages of operating through a company.
Accountant Oren Levy advises that companies must reassess their financial structures, dividend policies, and investment strategies to minimize exposure to the new tax. Failure to adapt could result in significant additional tax liabilities on accumulated funds. The law marks the end of an era where profits could be retained indefinitely without long-term tax planning, making proactive financial management essential for private business owners in Israel.
