- 4 -
Distributions ($323,399)
Loss (217,341)
Contributions (1,730)
Nondeductible officer insurance (4,355)
Sec. 274(n) expenditures (83,214)
Nondeductible fines (1,225)
Interest income 17,930
OPINION The controversy here is not over whether or which
reductions should be made to the AAA, but the order in which they
are to be made. The adjustments are to be made to the
accumulated adjustments account, which was statutorily created to
track certain aspects and the character of S corporation
distributions. In particular, the issue is whether an S
corporation's AAA must first be reduced by losses incurred by the
S corporation for the taxable year prior to determining the tax
treatment of shareholder distributions made during the year.
Petitioners argue that the tax treatment of distributions should
be considered prior to the consideration of annual losses, and
respondent argues the converse. In order to understand the
technical aspects of the controversy, it is necessary to
understand some of the background concerning the S corporation
provisions and the purpose of the statutes in question.
Sections 1367 and 1368 were enacted as part of the
Subchapter S Revision Act of 1982, Pub. L. 97-354, 96 Stat. 1669.
An S corporation, like a partnership, is a pass through entity
and, with certain exceptions, the shareholders report gain or
loss irrespective of any distributions made to them. Generally,
under sections 1367 and 1368, shareholder distributions are to be
tax-free to the extent of the distributee's stock basis. Further
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