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Thank You for the Update....and the Great Service as Always.
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The Accumulated Adjustments Account, or AAA, is a cumulative total of undistributed net income items generated by the Subchapter S corporation. This account is adjusted in the same fashion as a shareholder's basis. However, unlike stock basis, the AAA can have a negative balance resulting from Subchapter S corporation losses (but not from distributions to shareholders). Income in a later year can make the account positive only after the negative balance has been restored. Any decrease in stock basis has no impact on AAA when the AAA balance is negative.
The AAA is just like retained earnings, and it reconciled similarly.
The second column, the Other Adjustments Account, or OAA, is used only by a Subchapter S corporation that has accumulated E&P. The OAA is increased by tax-exempt income and decreased by related expenses and distributions to shareholders from the account. The account is also decreased by federal tax paid which is attributable to a C corporation tax year. The OAA can have a negative balance resulting from pass-through items, but a negative balance may not result from distributions to shareholders. Distributions from the OAA are not taxable to shareholders.
Some Subchapter S corporations have a retained earnings account called Previously Taxed Income (PTI). The PTI account represents undistributed earnings from pre-1983 Subchapter S corporation years. Unless your corporation is very old, you won't have this either.
To answer your two questions:
1) When you receive a distribution in excess of basis, your basis goes negative. When you report that distribution on your Schedule D of your personal Form 1040, it restores that negative basis to the extent that you report income. In other words, it brings your basis back to zero.
2) If your S-corporation made $10 profit that you reported on Schedule E of your Form 1040, and the corporation made no distributions to you during the year, you would receive $10 in basis.
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Thanks for the Answers….
The distributions other than dividends is terminology that is used because dividends are taxable returns of cash or property. Since the S-corp shareholder picks up the income whether or not it is distributed, the "dividends" that are paid to the owners are nontaxable distributions to the owner.
If the corporation had retained earnings from a time when it was a C-Corp, or if it had built-in gains from life as a C-corp, the dividends would be taxable.
The AAA account should normally have the same balance as the Retained Earnings account, so yes, at the end of the year the Retained Earnings account and the AAA account would be the same.
I hope this helps! Let me know if you have any more questions, or if anything is not clear.
I'm few follow up question....I will tip you $30
Sorry….I just need to clarify: Cash Distributions from profits of an S-Corporation to shareholder would not be reported on Schedule M-2 column (a) AAA
Schedule M-2 AAA…#8 Ending Balance should equal each year Profit and Loss from K-1’s, from when the S-Corporation was created and started their business activity? My going back several years and adding the Profit or Loss from each year should be the Ending Balance?
Schedule M-2 Other Adjustments Accounts that has accumulated E&P. Does this mean Yearly Profit from the S-Corporation reported on Schedule K-1 in which there was no Cash Distribution to the Shareholder equal to the profit of each year? Give me an example of Tax Exempt Income which will increase OAA?
That is NOT correct. Cash distributions out of the accumulated profits of an S-Corp that has always been an S-Corp ARE reported on the Schedule M-2, in Column A, on line 7. While corporate terminology calls it a dividend, for S-Corporations they are called nondividend distributions. Remember, the M-2 AAA account is the same as a retained earnings reconciliation for a corporation.
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I will double your fee of $38…..
Schedule M-2 AAA…#8 Ending Balance should equal each year Profit and Loss from K-1’s, from when the S-Corporation was created and started their business activity less and Cash Distributions? My going back several years and adding the Profit or Loss from each year less and Cash Distribution should be the Ending Balance?
You stated Unlike stock basis, the AAA can have a negative balance resulting from Subchapter S Corporation losses (But not from distributions to shareholder).
OK. I see where you are coming from. If you had over the years $900 of profits reported on the K-1, yet you have distributed $1000 of S-Corp "dividends" your retained earnings would be -100, yet your AAA beginning balance would be -0- and you would have picked up 100 on your personal return and paid tax as distributions in excess of basis. Then when you earn $10 in the next year, your RE would be -90, yet your AAA would be $10.
I guess I should adjust my prior statement. The GAAP Book Retained Earnings PLUS any distributions in excess of basis should equal the AAA account balance. The distribution in excess of basis is a tax concept, and your balance sheet is maintained on a GAAP basis. The AAA is a tax based reconciliation as well. So the difference between the two would be tax differences, which would be the distributions in excess of basis.
This is a more precise answer. I did not see late last night what you were getting at. I hope this clears things up!
Again, thanks, XXXXX XXXXX what is left of this holiday weekend!
1120S Schedule L- line 24- Retained Earnings is GAAP. The Books GAAP Balance Sheet always EQUAL 1120S Schedule L…and Retained Earning. M-1 Adjustments (Timing Difference) are always the difference in Book GAAP Profits and Tax Profit. Do you agree with this?
Schedule L –line 25 shows Shareholders Distributions?
If Schedule L- Retained earning showed $900 in life-to-date profits and Shareholders distributions (Schedule L –line 25) showed $1,000:
AAA would be $900 profit minus $100 distribution in excess of basis; ending balance of AAA = $800?
If this is correct, the AAA account will not equal Schedule L –line 24 –Retained Earnings?
If this is correct, the AAA Ending Balance will show Retained Earning minus excess Cash Distributions?
If this is correct, if the Distribution was $2,000 the AAA Ending balance would be zero (900 R/E – 1,100 Distribution in excess of basis)
Next Year when Capital Gains are Paid for the 1,100 distribution in excess of basis.
The beginning AAA account would be zero
(+) Profit of $40
Distribution of $10 (less than Profit)
Ending AAA = $40
If this is correct the AAA ending balance is never a reflection of all the Profit Life-to-Date (R/E), since the Excess Distributions of basis in any year would reduce the AAA Ending Balance, and, if the Excess Distributions is double the amount of R/E’s the AAA ending balance would be zero?
No, that is not correct.
Let's try a short example. Assume the corporation is 4 years old. Over those four years, the corporation earned $900 of income. In Year 5, the corporation had $100 of earnings, and distributed $1250 in S-Corp distributions. The Retained Earnings on Schedule L, line 24 would show -900 at the end of year 4. In year 5, the beginning Retained Earnings would be -900, plus $100 of income, less $1,250 of distributions, for an ending Schedule L retained earnings balance of -$250 on line 24. The S-Corp shareholder would have a distribution in excess of basis of $250, which he would report as a gain on his tax return in year 5.
At the beginning of year 5, the AAA account would be $900 line 1, column a. The $100 of income would be shown on Line 2, column a. Line 6, column a would show $1,000 as a subtotal. Line 7 would show $1,250 as distributions. What I do then, to avoid a negative on Line 8, is go back to Line 3, other additions, and put in $250 as distributions in excess of basis. Then the subtotal on Line 7 would be revised to $1250, less the $1250 distribution, showing a ZERO ending balance.
I have seen in practice some accountants who let the AAA account go negative, but this is not correct, as the distribution in excess of basis zeros out the negative amount and allows for further distributions.
Continuing my example from above, if in Year 6, the corporation makes $75 of income, and distributes $25, the distribution would not be excess of basis. The AAA account (all in column a) would show zero on line 1, line 2 would show the income of $75, line 5 would show a subtotal of $75, and line 6 would show the $75 of basis, then line 7 would show the $25 distribution, and line 8 would show $50 of remaining basis.
For the Schedule L in Year 6, the beginning balance of retained earnings would be -$250. This amount, plus $75 of income, less $25 distribution, would show an ending Schedule L retained earnings of -$200.
The difference between the Retained Earnings balance and the AAA account is the amount of distributions in excess of basis. So, if you take Retained Earnings PLUS (you have minus) the distributions in excess of basis, you will have the amount in the AAA account.
I hope my example makes things clear. If not, please let me know. I will be in and out this afternoon. so just let me know.
EXCELLENT…..Your examples worked wonders for my brain.
You mentioned Schedule L line 24 reflects the net of both Profits and Cash Distributions; can line 24 be used for just Profits and use line 25 for Shareholder Distributions? Line 25 states Adjustments to Shareholder equity. Separating the R/E from Distribution will clearly show what the Life-to-date Profits were, and what the Life-to-Date distributions were?
No, line 25 of Schedule L is for items such as restricted retained earnings and other unusual items. Sometimes retained earnings will be segregated or restricted due to loan covenants, or other agreements. This is where that goes. Also, prior period adjustments can be listed here. Distributions are a normal part of a corporation's activities, so they are included with retained earnings. That is just a GAAP rule.
I am glad that the example worked. Sometimes a picture is worth a thousand words! I am glad I could help!
I just read this from the IRS website:
An S corporation without accumulated E&P does not need to maintain the AAA in order to determine the tax effect of distributions.
I googled : Under current tax law, an S corporation cannot produce earnings and profits (E&P); only C corporations can. However, if the S corporation was previously a C corporation, it may have accumulated E&P from years when it was a C corporation. Similarly, if an S corporation was a party to a tax-free reorganization with another corporation that had accumulated E&P, the S corporation may have inherited the other corporation’s accumulated E&P. S corporations that have accumulated C corporation E&P can have both problems and opportunities. This article examines both and explores solutions.
Since the S-Corporation I have been discussing has never been a C-Corporation: I do have to keep track of M-2 AAA Column????
I believe this also applies to Other Adjustments Account?
No this is not true. GENERALLY, S-Corps have the same AAA as Retained Earnings. However, in some cases, such as yours, you DO need the AAA. When the S-Corp has distributions in excess of basis, you have to use the AAA account. Look at my example above. IF the AAA was not there, in Year 6 the deficit in Retained Earnings would indicate that the distribution was taxable, when it isn't.
The IRS publications cannot be relied on as authority. They are written to cover the most situations as possible, not all of them. So in some cases, such as yours, the AAA is required.
The Other Adjustments Account, and the Previously Taxed Income columns are not applicable to you.
I hope this answers your questions! Let me know if you have any more!