- 20 - that Bonnevista and Castle Towers had no accumulated earnings and profits as the result of reorganizations and the like. Accordingly, section 1368(c) is the applicable provision for determining the tax treatment of the distributions to petitioner arising from the discharge of his indebtedness to Bonnevista and Castle Towers. Under section 1368(c), distributions are deemed to come first from the S corporation’s so-called accumulated adjustments account (AAA), which is intended to measure the corporation’s accumulated taxable income that has not been distributed to shareholders. See sec. 1368(e); Williams v. Commissioner, 110 T.C. 27, 30 (1998). The AAA is increased by the S corporation’s income and is decreased by its losses and nontaxable distributions to shareholders. See secs. 1367 and 1368. The AAA is reduced first by current-year losses and deductions before considering shareholder distributions for the year. See Williams v. Commissioner, supra at 34. Distributions that do not exceed the AAA, like distributions from S corporations with no earnings and profits, are treated as tax free to the extent of the shareholder’s adjusted stock basis and then as capital gains. See sec. 1368(c)(1); sec. 1.1368-1(c), Income Tax Regs. Amounts distributed in excess of the AAA are next treated as dividends, and thus as ordinary income, to the extent of the S corporation’s accumulated earnings and profits. See sec. 1368(c)(2).Page: Previous 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 Next
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