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petitioners' suggested approach, the distributions would be a
nontaxable return of capital that decrease petitioner's tax basis
in his stock rather than result in a taxable dividend because the
1990 distributions did not exceed MTI's beginning of the year
AAA balance. Under respondent's determination, the $217,341 loss
for 1990 is subtracted from the AAA prior to considering the
effect of subtracting the distributions from the AAA.
Respondent's determination results in taxable dividends
attributable to MTI's accumulated earnings and profits of its
predecessor C corporation.
No Court has specifically analyzed the question of the
ordering of items in applying the principles for computing the
AAA and any resulting income or basis reductions. In Jones v.
Commissioner, T.C. Memo. 1997-400, we touched on, but did not
discuss, the point that adjustments to an S corporation's AAA for
losses and deductions incurred in a taxable year must be made
prior to adjustments for shareholder distributions.6 We do not
vary from that statement here but provide the rationale for our
holding and agreement. In so holding, we agree with respondent.
Petitioners contend that the order for required adjustments
to an S corporation's AAA is prescribed in section 1367(a).
Section 1367(a) provides a list of the positive and negative
6 The question of the ordering of reductions to the AAA was
not of critical import or effect in Jones v. Commissioner, T.C.
Memo. 1997-400, and, apparently, was not focused on by the
parties. Here, however, the ordering question is the essence of
the inquiry and central to the resolution of the controversy.
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