Excess S Corp Distributions

[BOB W]

Accounting Question: What journal entry(ies) need to be made (if any) to account for Capitial Gaines reporting for Excess Distributions over current year profits?

[OldJack]

profit v. basis

No S-corp separate entry. It is common to have S-corp distributions in excess of current profit. S-corp distributions in excess of shareholder "basis" that determines capital gain at the 1040 level is just that... at the 1040 level. Entry for any S-corp distribution is as a reduction of equity even if equity result is negative. Entry for the gain is usually recognized income.

[BOB W]

Thanks....

......Jack for your quick come-back.

[rosieea]

Where you're likely to see an effect is on the 1120S. If the distributions would take AAA below zero, which they cannot, there will be a difference between AAA and retained earnings.

[OldJack]

Where you're likely to see an effect is on the 1120S. If the distributions would take AAA below zero, which they cannot, there will be a difference between AAA and retained earnings.

IRS Instructions for form 1120S, page 35:

Note.The AAA may have a negative
balance at year end. See section
1368(e).

(e) Definitions and special rules
(C) Net loss for year disregarded
(i) In general
In applying this section to distributions made during any
taxable year, the amount in the accumulated adjustments
account as of the close of such taxable year shall be
determined without regard to any net negative adjustment for
such taxable year.
(ii) Net negative adjustment
For purposes of clause (i), the term "net negative
adjustment" means, with respect to any taxable year, the
excess (if any) of -
(I) the reductions in the account for the taxable year
(other than for distributions), over
(II) the increases in such account for such taxable year.

[JG EA]

Why do an AAA for an S?

If none of the reasons for one (used to be a C Corp/going to be a merger) why do one?
The instructions say it is "recommended", not required. I always do them unless they are different from retained earnings.
Then if they don't match - well that is too distressing so I just leave it blank.

[rosieea]

IRS Instructions for form 1120S, page 35:

Note.The AAA may have a negative
balance at year end. See section
1368(e).

Yes, AAA may have a negative balance, but not as a result of distributions. From the above cited instructions: "3. Decrease AAA (but not below zero) by property distributions..." Also see The Tax Book, page 19-9: "Unlike stock basis, the accumulated adjustments account can have a below-zero balance from losses (but not from distributions)..."

[OldJack]

Yes, AAA may have a negative balance, but not as a result of distributions.

I agree... its actually very simple when you think about it... you can't distribute something (AAA profit) that does not exist.

[OldJack]

If none of the reasons for one (used to be a C Corp/going to be a merger) why do one?
The instructions say it is "recommended", not required. I always do them unless they are different from retained earnings.
Then if they don't match - well that is too distressing so I just leave it blank.

Technically I believe every S-corp has a AAA account and certain transactions, such as tax-exempt income, are not allowed to be included in the AAA account. Therefore you could say a "AAA account" and a "Other Adjustments Account" are required even though the corporation has never been a C-corp with E&P (earnings & profits).

******
<< TAX TREATMENT OF SHAREHOLDERS

IRC Sec. 1367. Adjustments to basis of stock of shareholders, etc.
IRC Sec. 1368. Distributions

1368(e) Definitions and special rules
For purposes of this section -
(1) Accumulated adjustments account
(A) In general
Except as otherwise provided in this paragraph, the term
"accumulated adjustments account" means an account of the S
corporation which is adjusted for the S period in a manner
similar to the adjustments under section 1367 (except that no
adjustment shall be made for income (and related expenses)
which is exempt from tax under this title and the phrase "(but
not below zero)" shall be disregarded in section 1367(a)(2))
and no adjustment shall be made for Federal taxes attributable
to any taxable year in which the corporation was a C
corporation.>>


******
Instructions for 1120S, page 35:

<< S corporations with
accumulated E&P must maintain the
AAA to determine the tax effect of
distributions during S years and the
post-termination transition period. An S
corporation without accumulated E&P
does not need to maintain the AAA in
order to determine the tax effect of
distributions. Nevertheless, if an S
corporation without accumulated E&P
engages in certain transactions to
which section 381(a) applies, such as a
merger into an S corporation with
accumulated E&P, the S corporation
must be able to calculate its AAA at the
time of the merger for purposes of
determining the tax effect of
post-merger distributions. Therefore, it
is recommended that the AAA be
maintained by all S corporations.>>

******
Instructions for 1120S, page 35:

<< Column (b). Other
Adjustments Account
The other adjustments account is
adjusted for tax-exempt income (and
related expenses) and federal taxes
attributable to a C corporation tax year.
After these adjustments are made, the
account is reduced for any distributions
made during the year. See Distributions
on page 36. >>

[BOB W]

OK got it but.....

...... since I'm doing tax accounting how do I make a journal entry so the AAA is not effected by excess distributions? What accounts are effected? In other words what is the journal entry?

[OldJack]

Most booking for corporations do not have a separate account for Retained Earnings and AAA Account. You always have a Retained Earnings account and the AAA is just a sub-account of the Retained Earnings Account. The AAA is usually only split out on the tax return, however, you could have the separate general ledger account. If you have separate ledger accounts you would debit the AAA account for distributions until it is zero and the excess debited to the Retained Earnings account which would could result in a negative equity or debit balance. Actually for the current year distributions I usually have a separate account or listing on the financial statement for distributions which I then close at year end to Retained Earnings or if you wish the AAA account.

[rosieea]

...... since I'm doing tax accounting how do I make a journal entry so the AAA is not effected by excess distributions? What accounts are effected? In other words what is the journal entry?

Establish an Equity account ("Distributions"). Debit distributions, credit cash. At year's end do closing entries: Credit Distributions, debit Retained Earnings.

[BOB W]

Pti

I'm having a hard time digesting the Retained Earnings account entry, I need time to think it through and the effect. Years ago there was an account PTI ( Previously Taxed Income ) which was simular to AAA but had to be accounted for prior to the creation of AAA by the IRS. Maybe a separate account, sub account to retained earning, should be setup on the books to keep track of the excess distribution(s) that was taxed at CG rates. What do you all think?

[rosieea]

I'm having a hard time digesting the Retained Earnings account entry, I need time to think it through and the effect. Years ago there was an account PTI ( Previously Taxed Income ) which was simular to AAA but had to be accounted for prior to the creation of AAA by the IRS. Maybe a separate account, sub account to retained earning, should be setup on the books to keep track of the excess distribution(s) that was taxed at CG rates. What do you all think?

Bob, I'm sure you agree that distributions, whether excess or not, reduce retained earnings. Hence the closing entries. I'm sure you could set up things like you suggest - instead of a retained earnings account, you could have a AAA account and an Excess Distributions account, the sum of which would equal Retained Earnings. I've never seen that done, and it would surely complicate matters - especially since the determination of whether or not the distributions are excess may not be determinable on a month to month basis.

[OldJack]

I'm having a hard time digesting the Retained Earnings account entry, I need time to think it through and the effect. Years ago there was an account PTI ( Previously Taxed Income ) which was similar to AAA but had to be accounted for prior to the creation of AAA by the IRS. Maybe a separate account, sub account to retained earning, should be setup on the books to keep track of the excess distribution(s) that was taxed at CG rates. What do you all think?

There is no reason you could not have all the sub-accounts you wish. Retained Earnings is only an account of the profits and losses year to date of the corporation set-out from the other equity investment accounts. The corp can also allocate and have a separate "Appropriated Retained Earnings" account to reserved for a special purpose such as for constructing a building. Appropriated Retained Earnings is usually setup by a C-corp for purpose of documenting and avoiding the accumulated earnings tax.

A PTI account may still exist for some corporations and it is also a sub-account of Retained Earnings. The only real difference in the PTI account and the AAA account was that the tax law changed regarding how it was treated. The PTI account was allocated and belonged to a specific shareholder that earned the profit/loss for a specific year, whereas the AAA account belongs to any and all current shareholder based upon the number of shares.

Regarding the excess S-corp distributions subject to capital gains tax issue. The S-corp should not try to keep track of this as it is purely an individual shareholder 1040 issue. The corporation does not necessarily know if the shareholder is subject to the capital gains tax for excess distributions as the shareholder's basis (referred to as outside basis) is not necessarily the same as it would appear on the corporation books (inside basis) and 1120S-k1 entries. For the S-corp books, a property distribution is just that a distribution that must be reported as a distribution (AAA of profits, 1120S, pg3, line 16d), a distribution of E&P if prior C-corp earnings (1120S, pg 3, line 17c or 1120 taxable dividend 1099DIV, box 1), a liquidation distribution (1099DIV, box 8 or 9), or a distribution of return of capital (1099DIV, box 3).

The S-corp should simply account for the Retained Earnings account and the sub-account AAA for tax purposes (and any other sub-accounts if required).