An S Corporation elects to treat a distribution as coming from Accumulated E&P rather than the Accumulated Adjustments Account (AAA). Why might a shareholder want this?

Answer options:

To increase stock basis.

To avoid capital gains tax.

To avoid the Passive Investment Income tax or termination of S status.

To reduce the corporation's taxable income.

How to approach this question

Identify the 'Sting Tax' problem: S Corps with C Corp E&P + Passive Income > 25% of Gross Receipts. Solution: Distribute E&P (Election to bypass AAA).

Full Answer

C.To avoid the Passive Investment Income tax or termination of S status.✓ Correct

IRC §1368(e)(3) election. Distributing AEP eliminates the risk of the §1375 Passive Investment Income Tax and the §1362(d)(3) termination of S status.

Common mistakes

Thinking it's for basis reasons.

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