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'Accumulated Adjustments Account' -- what's being 'adjusted?'

April 30, 2009

A reader question:

I actually have a question concerning S corporation liquidation and hope you could answer me.

Say when a S corp liquidates, it has 800,000 balance in the AAA account. And when it liquidates, and distributes $1,000,000 proceeds to the sole shareholder, who has a stock basis of $200,000,

To determine the sole shareholder's gain or loss, should it be the proceeds amount minus the stock basis and minus the balance in AAA account(because it's a return a capital) and so there is no gain or loss recognized?

Or I shouldn't deduct the $800,000 amount of AAA and recognize $800,000 gain?

The response:

Thanks for your question. Unfortunately I don't have enough information to answer your question, and if I did too precisely, I'd probably have to charge you for it! But in general: - "AAA" stands for "accumulated adjustments account." The "adjustments" are adjustments to shareholder basis. If all returns have been filed correctly, an S corporation sole shareholder who has held his stock the entire time the corporation has been in existence will normally have no gain or loss on the liquidation. If a taxpayer starts a wholly-owned S corporation with a $200,000 investment and it builds up AAA of $800,000, his basis at that point is $1,000,000. He could withdraw that much with no gain or loss.

While there should be no gain or loss on a liquidation of a corporation that is an S corporation it's whole life without owner changes, mistakes can happen in tax returns that can throw this off. And often there have been owner changes, or the corporation has had a C corporation period prior to the S corporation election. In those situations, gain or loss on liquidation is the norm.

Link: IRS page on S corporations

Tags: AAA.basis.S corporation.

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