(6) Distributions from an S Corporation to its Shareholders.

(a) General rule regarding distributions from an S corporation to its shareholders . Unless otherwise excluded from gross income, actual distributions of cash or property by an S corporation with respect to its stock are included in the income of shareholders in a manner similar to that described in Code § 1368. Income, losses and deductions computed according to M.G.L. c. 62 are used to adjust Massachusetts basis, Massachusetts accumulated adjustments accounts, and Massachusetts Earnings and Profits. A taxable distribution is included in a shareholder’s Massachusetts gross income in the taxable year it is received or constructively received. (b) Massachusetts Accumulated Adjustments Accounts . Every S corporation must maintain a Massachusetts accumulated adjustments account (AAA) as defined in 830 CMR 62.17A.2(2) for purposes of determining the proper tax treatment of distributions, whether or not it is required to do so under Code § 1368. Except as to those S corporations that are subject to the rules otherwise provided in 830 CMR 62.17A.1, on the first day of the first taxable year for which the corporation is an S corporation for Massachusetts purposes, the balance of the AAA is the balance of the AAA for federal purposes. (c) Massachusetts Earnings and Profits . Every S corporation must maintain a Massachusetts Earnings and Profits account as defined in 830 CMR 62.17A.2(2) for purposes of determining the proper tax treatment of distributions during taxable years that an entity is treated as an S corporation for Massachusetts purposes, and also for taxable years it was not treated as such. (d) Overview of the tax consequences of distributions and the application of distributions against S corporation Massachusetts accounts and stock basis . The general effect of a distribution from an S corporation to a shareholder is to require the application of a cascading set of rules that determine whether and how the distribution is taxable to the shareholder, and the effect of the distribution on the shareholder’s basis in his or her stock. As explained in more detail in the specific rules below, an S corporation’s distribution to its shareholders is taken first from the S corporation’s AAA, which account contains amounts that have been previously reported to the S corporation’s shareholders as distributive share income and that has been taxed to such shareholders. Because such amounts have been previously taxed, have not been distributed to the S corporation’s shareholders, and have increased such shareholders’ basis in the S corporation stock, distributions from the AAA are tax-free to these shareholders, and correspondingly decrease the shareholders’ basis in the S corporation stock. Distributions from AAA in excess of basis are generally treated as a taxable gain from the sale or exchange of property. An S corporation may also have earnings and profits that derive from a period that the S corporation was previously a C corporation or from an acquisition by the S corporation of a C corporation that has earnings and profits. After the AAA is fully depleted, the next distributions from the S corporation to its shareholders are taken from the Massachusetts Earnings and Profits account. These distributions are taxable to the S corporation shareholders as dividends and have no effect on basis. In such cases, once the Massachusetts Earnings and Profits account is fully depleted, the same rules apply to shareholders of S corporations that have no Earnings and Profits account: further distributions from the S corporation to its shareholders are made tax-free to the shareholders to the extent of the shareholders’ basis in shares, and the distributions reduce the shareholders’ basis in the shares. Once an S corporation shareholder’s basis in shares is fully depleted, any further distribution from the S corporation to its shareholders is treated as taxable gain from the sale or exchange of property. (e) Specific rules on the consequences of distributions from an S corporation to its shareholders. Unless a distribution occurs in a post-termination transition period as defined at 830 CMR 62.17A.2(7) and the post-termination transition rules require otherwise, each distribution of property (including cash) from an S corporation shall be applied to reduce the AAA, the Massachusetts Earnings and Profits account, and Massachusetts adjusted shareholder basis in the S corporation shares according to rules set forth below. For adjustment to basis in a post-termination transition year, see 830 CMR 62.17A.2(7). For S corporations that were formerly treated as corporate trusts, see 830 CMR 62.17A.2(6)(f). 1. S Corporations with no Massachusetts Earnings and Profits. Each distribution of property (including cash) from an S corporation that has no Massachusetts Earnings and Profits shall have the following tax consequences and shall be applied to reduce the Massachusetts accumulated adjustments account and Massachusetts adjusted shareholder basis in shares, in the following order: a. The distribution shall not be included in the shareholder’s gross income to the extent that it does not exceed the shareholder's Massachusetts adjusted basis in the S corporation stock, as determined under 830 CMR 62.17A.2(5) and (6); the Massachusetts adjusted basis of the stock and the AAA shall be reduced by the amount of the distribution. b. If the amount of the distribution exceeds the shareholder’s Massachusetts adjusted basis in the S corporation stock, such excess is treated as gain from the sale or exchange of property. 2. S Corporations with Massachusetts Earnings and Profits. Each distribution of property (including cash) from an S corporation that has Massachusetts Earnings and Profits shall have the following tax consequences and shall be applied to reduce the AAA, the Massachusetts Earnings and Profits account, and the shareholder’s Massachusetts adjusted basis in the S corporation stock, in the following order: a. The portion of the distribution that does not exceed the Massachusetts accumulated adjustments account shall not be included in gross income to the extent it does not exceed the shareholder’s Massachusetts adjusted basis in the S corporation stock. The Massachusetts adjusted basis in the S corporation stock and the Massachusetts accumulated adjustments account shall be reduced by the amount of the distribution; b. In the event that a distribution exceeds Massachusetts adjusted basis but does not exceed the Massachusetts Accumulated Adjustment Account, the amount of such distribution shall be treated as taxable gain on the sale or exchange of property; c. To the extent a distribution exceeds the AAA but such excess distribution does not exceed accumulated Massachusetts Earnings and Profits, the amount of such excess distribution shall be taxable as a dividend to the extent of the Massachusetts Earnings and Profits account. The Massachusetts Earnings and Profits account to the extent thereof will be reduced by the amount of the distribution; d. After applying the rules in 830 CMR 62.17A.2(6)(e)(2)a. through c., where the AAA and the Massachusetts Earnings and Profits account are fully depleted, but the shareholder has an adjusted basis in the S corporation shares that is greater than zero, further amounts distributed are tax-free to the extent of any remaining shareholder’s Massachusetts adjusted basis in the S corporation stock; such basis shall be reduced by the amount of the distribution; and e. After applying the rules in 830 CMR 62.17A.2(6)(e)(2)a. through d, where the AAA and the Massachusetts Earnings and Profits account are fully depleted, and the shareholder has a zero basis in the S corporation shares, all additional amounts distributed shall be treated by the shareholder as gain from the sale or exchange of property. 3. Massachusetts generally follows the federal election to treat certain distributions as dividends, as provided in Code § 1368(e)(3); this election may not be made solely for Massachusetts purposes. (f) Rules for S corporations that were formerly treated as corporate trusts. Prior to tax years beginning on or after January 1, 2009, certain entities were subject to taxation as corporate trusts under the now-repealed M.G.L. c. 62, § 8. See St. 2008, c. 173. Entities that were formerly taxed as corporate trusts at the entity level are subject to special rules with respect to the taxation of their tax-free earnings and profits. See 830 CMR 62.17A.2(3)(h), 830 CMR 63.30.3(3)(d). Rules for recognizing income to S corporation shareholders that derives from these tax-free earnings and profits are set forth in 830 CMR 63.30.3(3)(d), (4)(a), (4)(a)2., (4)(c)2. The tax-free earnings and profits amounts attributable to each S corporation shareholder do not become a part of the AAA or the Massachusetts Earnings and Profits account. Rather, distributions from the S corporation are treated first as paid from tax-free earnings and profits until this account is exhausted. Such payments are taxable to shareholders as described in 830 CMR 63.30.3: Entity Classification Under St. 2008, c. 173 , and neither reduce nor increase the AAA or the Massachusetts Earnings and Profits account. The effect of such distributions on a shareholder’s basis is explained in 830 CMR 63.30.3, Entity Classification Under St. 2008, c. 173, particularly at 830 CMR 63.30.3(3)(d)4. and (4)(a)2: Change from a Corporate Trust to a Corporation .