Steven R. and Terry D. Williams - Page 1

                                   110 T.C. No. 4                                     

                               UNITED STATES TAX COURT                                

                   STEVEN R. AND TERRY D. WILLIAMS, Petitioners v.                    
                    COMMISSIONER OF INTERNAL REVENUE, Respondent                      

               Docket No. 18298-95.                 Filed January 21, 1998.           

                    P, a shareholder in an S corporation (S), received                
               a 3X distribution from S during 1990.  S's Accumulated                 
               Adjustment Account (AAA), under sec. 1368, I.R.C., had                 
               a 3X balance as of the beginning of 1990.  S had a 2X                  
               loss for 1990.  When subch. S status was elected for S,                
               its predecessor subch. C corporation had in excess of                  
               2X accumulated earnings and profits.  To the extent                    
               that the 3X distribution for 1990 exceeds the balance                  
               of the AAA, P would be taxable for such excess as a                    
               dividend to the extent it did not exceed the                           
               accumulated earnings and profits from the predecessor                  
               subch. C corporation.  R determined that the 2X loss                   
               should be first subtracted from the 3X balance of the                  
               AAA before considering the 1990 distribution.  R's                     
               determination would result in taxable ordinary income                  
               to P.  P counters that distributions should be first                   
               subtracted from the AAA prior to any adjustments for                   
               losses or deductions of the subch. S corporation for                   
               the year.  Held:  Losses and deductions for the year                   
               are to be first subtracted from the AAA prior to                       
               considering shareholder distributions for the year.                    
               Secs. 1367 and 1368 interpreted.                                       

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