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petitioners' interpretation of section 1367. Section 1367 merely
lists the adjustments to basis of shareholder's stock and does
not prescribe the order in which those adjustments are to be made
for present purposes.
The AAA must be adjusted for income, loss, and deductions of
an S corporation for the taxable year prior the adjustment to the
AAA for shareholder distributions. Section 1368(c) requires that
if distributions made during a taxable year exceed the amount in
the AAA at the close of the taxable year, the balance of the AAA
is to be allocated among the distributions. Petitioners contend
that adjustments for both losses and shareholder distributions
can occur at the end of the year, consistent with section
1368(c), and the adjustment for distributions could occur before
the adjustment for losses. However, the legislative history of
section 1368(c), like that of section 1367, expressly states that
adjustments to the AAA for current year losses are made before
adjustments for distributions during the year. The House report
provides:
for any taxable year, the amount in the account (after
taking into account income and loss for the taxable
year) will be used up pro rata among all distributions
made during the year. Thus, if the account balance at
the end of a year, before distributions, is $100 and
the corporation distributed $200 during the taxable
year, one-half of each distribution will be treated as
from the accumulated adjustments account and therefore
will not be taxed as a dividend. [H. Rept. 98-432
(Part II), at 1645 (1984); emphasis added.]
Subsequent to the taxable years in question, regulations
under sections 1367 and 1368 were issued requiring taxpayers to
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