The IRS has issued guidance on treatment of cash distributions made when a former S corporation (now a C corporation) redeems stock during the post-termination transition period.
Post-Termination Transition Period and Accumulated E&P
Once S corporation status ends, C corporation rules generally apply.
There are, however, special rules for distributions during a designated period after S status ends, known as the post-termination transition period.
For example, distributions from a C corporation are generally taxable. However, cash distributions during the post-termination transition period are applied against the shareholder’s adjusted stock basis to the extent of the accumulated adjustments account (AAA). The AAA measures an S corporation’s accumulated earnings and profits (E&P) and certain other transactions.
Generally, accumulated E&P are the earnings and profits from when the S corporation was a C corporation before electing S corp status.
IRS Redemption Example
The new guidance provides an example of a stock redemption during a former S corporation’s post-termination transition period. In the example:
- An individual, owns all 100 shares of the corporation’s outstanding stock.
- When the corporation converted to S corporation status, the corporation had accumulated earnings and profits (E&P) of $600x and no current E&P.
- When its S election terminated, the corporation’s AAA was $800x and its accumulated E&P was still $600x.
During the post-termination transition period, the shareholder redeems 50 of the 100 shares of stock for $1,000x. The transaction is treated as a distribution in redemption of stock.
The corporation makes no other distributions during the post-termination transition period.
In this case, the corporation should:
- reduce its AAA by $800x; and
- characterize the remaining amount (distribution in excess of AAA) as a dividend.
Rev. Rul. 2019-13
Topic: Revocation and Termination of S Corporation Status
Code Sec. 1371