Steven R. and Terry D. Williams - Page 9

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          contend that section 1368(d) refers to the section 1367 stock               
          basis adjustments for the proper order of adjustments to the AAA.           
               Respondent maintains that section 1368, and not section                
          1367, controls the order of adjustments to the AAA.  Section                
          1368(d), relied on by petitioners, provides that the tax                    
          treatment of shareholder distributions under section 1368(b) and            
          (c) shall be determined by taking into account the adjustments to           
          the basis of the shareholder's stock under section 1367 and the             
          adjustments to the AAA under section 1368(e)(1).  Section 1368(e)           
          controls the adjustments to the AAA of an S corporation for                 
          current year operating results and shareholder distributions and            
          provides that the AAA is to be adjusted in a manner similar to              
          the adjustments to the basis of S corporation stock provided in             
          section 1367.  Sec. 1368(e)(1)(A).                                          
               Petitioners' reliance on section 1367 for the timing or                
          order of adjustments to the AAA is misplaced.  The section 1367             
          legislative history states that the current year's losses                   
          decrease the basis of S corporation stock before the stock basis            
          is decreased for shareholder distributions and supports our                 


          (...continued)                                                              
                    1366(a)(1),                                                       
                         (D) any expense of the corporation not                       
                    deductible in computing its taxable income and not                
                    properly chargeable to capital account, and                       
                         (E) the amount of the shareholder’s deduction                
                    for depletion for any oil and gas property held by                
                    the S corporation to the extent such deduction                    
                    does not exceed the proportionate share of the                    
                    adjusted basis of such property allocated to such                 
                    shareholder under section  613A(c)(13)(B).                        




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