1120-US: Distributions reducing the Accumulated Adjustments account when the ending balance is negative (FAQ)

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Question

Why are distributions reducing the Accumulated Adjustments account when the ending balance is negative?

Answer

Per the 1120S Schedule M-2 instructions, the accumulated adjustments account is adjusted in the following order:

  1. Increased by income items, other than tax-exempt income.
  2. Generally, decreased by deductible losses and expenses, nondeductible expenses, other than expenses related to tax-exempt income. However, if the total decreases, exceeds the total increases, the excess is a net negative adjustment. If the corporation has a net negative adjustment, do not take the negative adjustment into account. Instead, take the negative adjustment into account only under step 4, below.
  3. Decreased, but not less than zero, by property distributions, other than dividend distributions from accumulated E & P, unless the corporation elects to reduce accumulated E & P first.
  4. Decreased by any net negative adjustment.

If the S Corporation has a net negative adjustment, the accumulated adjustments account is first reduced by the distributions, but not less than zero. Any remaining amount of the accumulated adjustment account is then reduced by the net negative adjustment.

Note: If you want to allow the distributions to reduce the Accumulated Adjustment Account less than zero, see Allowing distributions to reduce Accumulated Adjustment Account below zero.

Related topic: 1120-US: Form 1120S - common FAQs

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