New planning opportunities for distributions from S corporations.

• Author: Belkin, Eileen W.
• Position: Brief Article

Distributions from an S corporation may or may not be taxable to a shareholder, depending on the following factors: The shareholder's basis in the S stock (as defined by Sec. 1367), the balance in the S corporation's accumulated adjustments account (AAA) (as computed under Sec. 1368), and whether or not the S corporation has accumulated earnings and profits (AE&P) from a prior C corporation year, in which case Sec. 1368(c) applies.

Secs. 1366 and 1368, amended by the Small Business Job Protection Act of 1996 (SBJPA), contain specific ordering rules for the basic computations required of a shareholder to determine whether a distribution is taxable, and if it is taxable, whether it is from E&P and therefore taxable as a dividend or from AAA and taxable as capital gain. Due to the new provisions, it is possible that a shareholder will receive a tax-free distribution in excess of his tax basis in certain circumstances. In addition, the new provisions also make it possible for an S corporation with AEAP to make a distribution in excess of its AAA that will not result in a taxable dividend to the shareholder.

The first of these new amendments provides that the adjustment for distribution made by an S corporation during a loss year is taken into account before applying the loss limitations for that year (SBJPA) Section 1309(a)(1) and (2), amending...