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11549: 1120S - AAA Distributions

1120S Sub S Corporate

How are Schedule M-2 AAA Distributions different?

AAA (Form 1120S, Schedule M-2) distribution amount is different than the amount entered in the program.

Reg § 1.1368.2 explains the ordering rules and why the distribution is being limited.

"(5) Ordering rules for the AAA for taxable years beginning on or after August 18, 1998. For any taxable year of the S corporation beginning on or after August 18, 1998, the adjustments to the AAA are made in the following order—
    (i) The AAA is increased under paragraph (a)(2) of this section before it is decreased under paragraph (a)(3)(i) of this section for the taxable year;
    (ii) The AAA is decreased under paragraph (a)(3)(i) of this section (without taking into account any net negative adjustment (as defined in section 1368(e)(1)(C)(ii)) before it is decreased under paragraph (a)(3)(iii) of this section;
    (iii) The AAA is decreased (but not below zero) by any portion of an ordinary distribution to which section 1368(b) or (c)(1) applies;
    (iv) The AAA is decreased by any net negative adjustment (as defined in section 1368(e)(1)(C)(ii)); and
    (v) The AAA is adjusted (whether negative or positive) for redemption distributions under paragraph (d)(1) of this section.

Page 43 of the Instructions for Form 1120S indicate the following:

"On the first day of the corporation's first tax year as an S corporation, the balance of the AAA is zero. At the end of the tax year, adjust the AAA for the items as explained below and in the order listed.

1. Increase the AAA by income (other than tax-exempt income) and the excess of the deduction for depletion over the basis of the property subject to depletion (unless the property is an oil and gas property the basis of which has been allocated to shareholders).

2. Generally, decrease the AAA by deductible losses and expenses, nondeductible expenses (other than expenses related to tax-exempt income), and the sum of the shareholders' deductions for depletion for any oil or gas property held by the corporation as described in section 1367(a)(2)(E). If deductible losses and expenses include the fair market value of certain contributed property (discussed earlier), further adjust AAA by adding back the fair market value of the contributed property and subtracting instead the property's adjusted basis. If the total decreases under (2) exceed the total increases under (1) above, the excess is a “net negative adjustment.” If the corporation has a net negative adjustment, do not take it into account under (2). Instead, take it into account only under (4) below.

3. Decrease AAA (but not below zero) by property distributions (other than dividend distributions from accumulated E&P), unless the corporation elects to reduce accumulated E&P first. See Distributions, later
[in the 1120S instructions], for definitions and other details.

4. Decrease AAA by any net negative adjustment. For adjustments to the AAA for redemptions, reorganizations, and corporate separations, see Regulations section 1.1368-2(d).

Note. The AAA may have a negative balance at year end. See section 1368(e).

By applying the ordering rules listed above we see how a distribution of $65,000 is limited in the example below:

AAA beginning balance     (11786)
Ordinary income (5(i))      58440
Other reductions (5(ii))        (489)
Available for Distribution      46165
Distributions (5(iii))     (46165)
Balance at end of year            -0-

To take any amount greater than available would allow the distribution to take the AAA below zero, which 5(iii) clearly indicates is not allowed.

This is not to say that distributions are not allowed for the shareholders, but that the distributions may be taxable to the shareholders due to the lack of basis in the AAA account.  Please refer to Internal Revenue Code Section 1368.

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