Proposed Regulations Issued for Post S-Corporation Termination Distributions

The Tax Cuts and Jobs Act added a provision that affected so-called Post Termination Transition Period distributions from former S-corporations. 

The original rule under section 1371(e) established the so-called Post Termination Transition Period. This is the period after an S-corporation termination in which the former S-corporation can make distributions out of their former S-corporation Accumulated Adjustment Account (AAA). Shareholders of the former S-corporation can take these distributions tax free to the extent of the basis in their stock. 1371(e) has a time limit of generally one year after the termination of the S-election, so any distributions after this period would follow the C-corporation distribution rules and any AAA not distributed would most likely be lost.

The Tax Cuts and Jobs Act added section 1371(f), which governs the period after the Post Termination Transition Period. This new provision allows for additional distributions of former S-corporation AAA. The general rules allow for additional distributions of AAA in a ratio of AAA to earnings and profits (E&P). However, there were some unknowns related to this new provision. For example:

  • How do you treat shareholders who join after the S-corporation termination?
  • How and when do you calculate the ratio of AAA to E&P?

The IRS issued proposed regulations on November 4th of this year to answers some of the outstanding questions and to “ease the transition from S-corporation status to C-corporation status.”

The questions regarding section 1371(f) that garnered the most attention were answered in the proposed regulations:

  • Shareholders who join after the termination of the S-corporation are eligible to receive the same allocation of AAA as the shareholders of record on the termination date
  • The ratio of AAA to E&P used to calculate the portion of distributions allocated to the former S-corporation’s AAA is calculated once, as of the date the S-corporation status is terminated

The tax rules for the new Code Section 1371(f) are more complicated than can be covered in this article. If you believe this code section and the proposed regulations regarding this code section apply to you, please consult with your professional tax advisor.