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such tax-free distributions reduce the shareholder's stock basis.
In accord with these concepts, the above-mentioned act also
obviated the conceptual need for corporate earnings and profits,
except to the extent that an S corporation may possess
accumulated earnings from prior years in which it was a
subchapter C corporation. See sec. 1371(c).
Where earnings and profits accumulated by a predecessor C
corporation exist, they are taken into account in the tax
treatment of distributions to S corporation shareholders. This
is accomplished through a clearing concept designated as the AAA.
The AAA is described and defined in section 1368(e)(1), as
follows:
(e) Definitions and Special Rules.--For purposes
of this section--
(1) Accumulated adjustments account.--
(A) In general.--Except as provided in
subparagraph (B), the term "accumulated
adjustments account" means an account of the
S corporation which is adjusted for the S
period in a manner similar to the adjustments
under section 1367 (except that no adjustment
shall be made for income (and related
expenses) which is exempt from tax under this
title and the phrase "(but not below zero)"
shall be disregarded in section
1367(b)(2)(A)) and no adjustment shall be
made for Federal taxes attributable to any
taxable year in which the corporation was a C
corporation. * * *
An S corporation distribution from accumulated earnings and
profits of a predecessor C corporation is treated as a dividend
to the extent that the distribution exceeds the S corporation's
AAA. Sec. 1368(c)(1) and (2). The AAA is intended to measure
the accumulated taxable income of an S corporation that has not
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