Distribution by former S corporation is part dividend

By Sally P. Schreiber, J.D.

In Rev. Rul. 2019-13, the IRS ruled that a distribution to the sole shareholder of a C corporation was partly a recovery of the former S corporation’s accumulated adjustments account (AAA) and a taxable dividend for the remaining distribution.

The company involved was originally a C corporation that had accumulated earnings and profits (E&P) of $600x when it converted to an S corporation. (The sole shareholder held all 100 shares of stock in the corporation.) When the corporation terminated its S election, it had an AAA of $800x and continued to have the $600x of C corporation E&P.

During the corporation’s S corporation post-termination transition period, the corporation redeemed 50 of the 100 outstanding shares for $1,000x. The corporation made no other distributions during the post-termination transition period. Pursuant to Sec. 302(d), the redemption is characterized as a distribution subject to Sec. 301. For the tax period that includes the redemption, the corporation had current E&P of $400x.

The IRS ruled that if, during a former S corporation’s post-termination transition period, the corporation

distributes cash in redemption of a shareholder’s stock, which is characterized as a distribution subject to Sec. 301, the corporation should reduce its AAA to the extent of the proceeds of the redemption pursuant to Sec. 1368. Consequently, the IRS ruled that $800x of the distribution should first reduce the S corporation’s AAA under Sec. 1368 (which was not taxable) and that the remaining $200x was a taxable dividend under Sec. 301.

— Sally P. Schreiber, J.D., (Sally.Schreiber@aicpa-cima.com) is a Tax Adviser senior editor.

Newsletter Articles

50th ANNIVERSARY

50 years of The Tax Adviser

The January 2020 issue marks the 50th anniversary of The Tax Adviser, which was first published in January 1970. Over the coming year, we will be looking back at early issues of the magazine, highlighting interesting tidbits.

TAX RELIEF

Quirks spurred by COVID-19 tax relief

This article discusses some procedural and administrative quirks that have emerged with the new tax legislative, regulatory, and procedural guidance related to COVID-19.