Distributions from AAA
From TaxAlmanac
IRS code and regulations stipulate the following items concerning distributions from an S Corporation Accumulated Adjustments Account:
The account should be adjusted for S Corporation income and deductions (both separately and non-separately stated items) and nondeductible expense (unless they relate to tax exempt income), as well as distributions to shareholders. (Code Section 1368(e)(1)). When adjustments are made for distributions to shareholders, those adjustments must first take into account the adjustments made to shareholder stock basis, and the adjustments mentioned above for income, deductions, and nondeductible expenses. (Code Section 1368(d))
Where there are taxes attributable to a C Corporation tax year, no adjustment can be made to the AAA for those taxes. (Code Section 1368(e)(1)).
The AAA balance cannot be reduced below zero by distributions to shareholders. (Reg. 1.1368-2(a)(4)(iii)).
According to Reg. 1.1368-1, distributions should reduce Schedule M-2 accounts in the following order:
1) AAA
2) Previously Taxed Income
3) Earnings and Profits
4) Other Adjustments Account
5) Stock Basis