Steven R. and Terry D. Williams - Page 5

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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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