REG CPA Practice Questions Explained: How to Calculate the S Corporation AAA (Accumulated Adjustments Account)

How to Calculate the S Corporation AAA (Accumulated Adjustments Account)

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In this video, we walk through 4 REG practice questions teaching how to calculate the S Corporation AAA (Accumulated Adjustments Account). These questions are from REG content area 5 on the AICPA CPA exam blueprints: Federal Taxation of Entities.

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How to Calculate the S Corporation AAA (Accumulated Adjustments Account)

The Accumulated Adjustments Account (AAA) is a key component in the taxation and financial management of S corporations. It serves to track undistributed income that has been taxed at the shareholder level. Understanding the AAA is crucial for both shareholders and managers of S corporations to ensure proper tax treatment of distributions and avoid potential double taxation.

What is the Accumulated Adjustments Account (AAA)?

The AAA is an account used exclusively by S corporations to track the tax attributes of income that has been taxed to shareholders but not yet distributed. It helps in determining the tax effects of distributions to shareholders.

Rules Governing the AAA

  1. Formation and Purpose:
    • Formation: Begins when the corporation elects S status.
    • Purpose: To prevent double taxation on distributions of income that has already been taxed to shareholders but not yet distributed.
  2. Increases to AAA:
    • Taxable Income: Includes net ordinary business income and net rental income.
    • Separately Stated Income Items: Such as net capital gains and certain gains on the sale of assets.
    • Adjustments: Specific tax deductions like the dividends-received deduction.
  3. Decreases to AAA:
    • Losses and Deductions: Includes net operating losses, business expense deductions, and other allowable deductions.
    • Nondeductible Expenses: Certain fines, penalties, and expenses not deductible for tax purposes (e.g., entertainment expenses).
    • Distributions: Distributions to shareholders reduce the AAA, but cannot reduce it below zero.
  4. Limitations and Special Rules:
    • Cannot Go Below Zero Due to Distributions: If distributions exceed the AAA, the excess does not create a deficit but affects other tax aspects like reducing the shareholders’ stock basis or being treated as dividends if there is accumulated E&P.
    • Ordinary Losses: Ordinary losses can reduce the AAA below zero, reflecting the corporation’s overall taxable loss position.


Example 1: Increasing AAA

  • Starting AAA: $50,000
  • Activities During the Year:
    • Net Ordinary Business Income: $100,000
    • Long-term Capital Gain: $20,000
    • Dividends Received (eligible for deduction): $5,000
  • End of Year AAA Calculation:
    • Starting AAA ($50,000) + Income ($100,000) + Capital Gain ($20,000) + Dividends ($5,000) = $175,000

Example 2: Decreasing AAA (including shareholder distributions)

  • Starting AAA: $150,000
  • Activities During the Year:
    • Ordinary Business Loss: -$30,000
    • Short-term Capital Loss: -$10,000
    • Nondeductible Expenses: -$5,000
    • Distributions: -$120,000
  • End of Year AAA Calculation:
    • Starting AAA ($150,000) – Losses (-$40,000) – Nondeductible Expenses (-$5,000) = $105,000
    • After Distributions: $105,000 – $120,000 = -$15,000 (AAA stops at $0, excess distributions of $15,000 affect other accounts)

Example 3: AAA Becoming Negative

  • Starting AAA: $30,000
  • Activities During the Year:
    1. Net Ordinary Business Loss: -$70,000 (significant operational losses)
    2. Nondeductible Expenses: $5,000 (expenses not deductible for tax purposes)
  • Calculation of AAA:
    • Start with the Existing AAA
      • Starting AAA: $30,000
    • Adjust for Losses
      • Subtract Ordinary Business Loss: $30,000 – $70,000 = -$40,000 (AAA now becomes negative)
    • Subtract Nondeductible Expenses
      • Subtract Nondeductible Expenses: -$40,000 – $5,000 = -$45,000
  • End of Year AAA:
    • The final AAA balance is -$45,000. This negative balance reflects the operational losses and nondeductible expenses incurred during the year.

How to Use AAA in Practice

Managing the AAA involves careful accounting and tax planning, especially around the issue of distributions. Properly managing the AAA can help avoid unintended tax consequences and ensure that distributions are done in a tax-efficient manner. For tax planning, it’s essential to anticipate how business activities will affect the AAA and plan distributions accordingly.

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