(5) For purposes of determining the treatment of a distribution, the amount in the AAA at the

closeof any taxable year is determined without regard to any net negative adjustment (i.e.,
the excess of reductions over increases to the AAA for the taxable year) for such taxable year.
b. Distributions in excess of the AAA are treated as ordinary dividends to the extent of the corpora-
tion's accumulated earnings and profits (AEP). These amounts represent earnings and profits
that were accumulated (and never taxed to shareholders) during C corporation taxable years.

c. Distributions are next nontaxable to the extent of remaining stock basis and are applied to re-
duce the OAA and paid-in capital.

d. Distributions in excess of stock basis are treated as gain from the sale of stock.
EXAMPLE: A calendar year S corporation had subchapter C accumulated earnings and profits of $10,000 at De-
cember 31, 2008. During calendar year 2009, the corporation had net income of $20,000, and distributed $38,000
to its sole shareholder on June 20, 2009. Its shareholder had a stock basis of $15,000 at January 1, 2009.

The $20,000 of net income passes through and is includible in gross income by the shareholder for 2009. The
shareholder's stock basis is increased by the $20,000 of income (to $35,000), as is the AAA which is increased to
$20,000. Of the $38,000 distribution, the first $20,000 is nontaxable and (1) reduces stock basis to $15,000, and
(2) the AAA to zero; the next $10,000 of distribution is reported as dividend income (no effect on stock basis);
while the remaining $8,000 of distribution is nontaxable and reduces stock basis to $7,000.
12.Health and accident insurance premiums and other fringe benefits paid by an S corporation on behalf
of a more than 2% shareholder-employee are deductible by the S corporation as compensation and in-
cludible in the shareholder-employee's gross income on Form W-2.

13. An S corporation (that previously was a C corporation) is taxed on its net recognized built-in gain if

the gain is (1) attributable to an excess of the FMV of its assets over their aggregate adjusted basis as
of the beginning of its first taxable year as an S corporation, and (2) is recognized within ten years
after the effective date of its S corporation election.

a. This provision generally applies to C corporations that make an S corporation election after De-
cember 31, 1986.

b. For S corporation tax years beginning in 2009 and 2010, the recognition period is reduced to seven
years (e.g., the recognition period will end at the beginning of 2009 if the S election was made for
the 2002 tax year). -
c. To determine the tax, (1) take the lesser of (a) the net recognized built-in gain forthe taxable year,
or (b) taxable income determined as if the corporation were a C corporation (except the NOL and
dividends-received deductions are not allowed); (2) subtract any NOL and capital loss carryfor-
wards from Ccorporation years; (3) multiply the resulting amount' by the highest corporate tax
rate (currently 35%); and (4) subtract any general business credit carryovers from C corporation

years and the special fuels tax credit. . ,

d. Any net recognized built-in gain that escapes the built-in gains tax because of the taxable income
limitation is carried forward and is subject to the built-in gains tax to the extent the corporation
subsequently has other taxable income (that is not already subject to the built-in gains tax) for any
taxable year within the ten-year recognition period.

e. Recognized built-in gain does not include gain from the disposition of an asset if
(1) The asset was not held by the corporation when its S election became effective (e.g., an asset
was purchased after the first day of its S election), or

(2) The gain is attributable to appreciation that occurred after the S election became effective
(e.g., an asset is sold for a gain of $1,000, but $600 of its appreciation occurred after the first
day of its S election; the corporation would be taxed on only $400 of gain).
f. The total amount of net recognized built-in gain that will be taxed to an S corporation is limited to
the aggregate net unrealized built-in gain when the S election became effective.

g. The built-in gains tax that is paid by an S corporation is treated as a loss sustained by the S cor-
poration during the taxable year. The character of the loss is determined by allocating the loss
proportionately among the recognized built-in gains giving rise to such tax.

EXAMPLE: For 2009, an S corporation has taxable income of $100,000, which includes a $40,000 long-term
capital gain that is also a recognized built-in gain. Since its recognized built-in gain of $40,000 is less than its
taxable income, its built-in gains tax for 2009 is $40,000 x 35% = $14,000. Since the built-in gain was a long-
term capital gain, the built-in gains tax paid of $14,000 is treated as a long-term capital loss. As a result, a net
long-term capital gain of $2.6,000 ($40,000 LTCG - $14,000 LTCL) passes through to shareholders for 2009. ,
MODULE 36 TAXES: CORPORATE
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