An S Corporation has substantial AAA and AEP. The shareholders have high basis. They want to distribute AEP to avoid the passive investment income tax but want to minimize total distributions. What planning tool should they use?

Answer options:

Make a regular distribution.

Make an election to bypass AAA.

Liquidate the corporation.

Contribute more capital.

How to approach this question

Identify the 'AAA Bypass Election' (IRC §1368(e)(3)). This reverses the ordering rule, allowing AEP to be drained without exhausting AAA first.

Full Answer

B.Make an election to bypass AAA.✓ Correct

IRC §1368(e)(3). An S Corp can elect to treat distributions as coming from AEP first. This is useful to purge AEP to avoid the 'sting tax' on passive income.

Common mistakes

Assuming distributions always come from AAA first.

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