ACC610DiscussionsWeek 4 - Discussion 1-AEP

Week 4 - Discussion 1

Dear Collette,

Subject: Accumulated earnings and profits (AEP), AAA for S corporation.

As far as I can see, your S company already has AEP accrued. Thus, to have accrued AEP, your legal organization must have operated as a C company or AEP as a Limited company. However, if your AEP is the result of your company’s former status as a C corporation, any distributions from your AEP will be subject to dividend taxation. In addition, as long as the distribution amount does not surpass your stock basis, any profits from your S business will be tax-free. A dividend that does not exceed the stock basis is a tax-free capital restoration if you are not a C Corporation.

As seen on page 13 of chapter 12 of Hoffman, Raabe, Smith, Maloney, and Young (2016). This is why it’s so important to have a AAA credit rating since it determines whether a payout should be paid as a dividend. Last but not least, any residual sum after AEP distribution is applied to the other adjustments account and then to the shareholder’s remaining stock basis. After their stock basis has reached zero, Distributions made to shareholders will be taxable as capital gains. The recovery of capital via the decrease in stock basis is not subject to tax.

The modest AEP would disappear from the financial accounts, and future tax planning would be less problematic if you forego election and redistribute out of AEP first. If, on the other hand, you decide to make use of the AAA, your AEP will remain unchanged until you make a withdrawal.

Johnnie Sims.

Reference

Hoffman, W. H., Raabe, W. A., Smith, J. E., Maloney, D. M., & Young, J. C. (2016). South-western federal taxation 2016: Corporations, partnerships, estates and trusts (39th ed.). Mason, OH: Southwestern Cengage Learning.