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decrease the AAA by current year losses prior to determining the
tax consequences of any distribution made during the taxable
year. Secs. 1.1368-1(e), 1.1368-2(a)(4), Income Tax Regs. The
regulations apply to tax years of a corporation beginning on or
after January 1, 1994, and are not applicable to this case. Sec.
1.1368-4, Income Tax Regs.
Ironically, during 1996 Congress amended section 1368(e) to
provide for the result that petitioners seek. Small Business Job
Protection Act of 1996, Pub. L. 104-188, sec. 1309(c)(2), 110
Stat. 1755, 1784. Section 1368(e)(1)(C), as amended, provides
that the AAA is adjusted for distributions made during the year
without regard to any net negative adjustment for the year. A
net negative adjustment is the excess of reductions in the AAA
for losses and deductions for the year over any increase in the
AAA for the year. The amendment applies to tax years beginning
after December 31, 1996. The legislative history of section
1368(e)(1)(C) makes it clear that Congress intended to effect a
change in the existing law. Congress characterized the existing
law as follows:
Under present law, income (whether or not taxable)
and expenses (whether or not deductible) serve,
respectively, to increase and decrease an S corporation
shareholder's basis in the stock of the corporation.
These rules require that the adjustments for items of
both income and loss for any taxable year apply before
the adjustment for distributions applies.
These rules limiting losses and allowing tax-free
distributions up to the amount of the shareholder's
adjusted basis are similar in certain respects to the
rules governing the treatment of losses and cash
distributions by partnerships. Under the partnership
rules (unlike the S corporation rules), for any taxable
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