Distributions from S-Corp that has losses

I have a new client and his situation poses a few challenges. To start with, he doesn't have the best accounting records.

However, the thing that troubles me most is trying to figure out how to categorize 'distributions' that he gives himself from an S-Corp. He treats these distributions basically as equity distributions while he shows no income from the S-Corp. To be fair there is no operating income from what I can see. I just need to sort out how to deal with the distributions that appear to be 'guaranteed' distributions he gives himself.

His prior accountant showed an ordinary business loss from this S-Corp and showed no taxable income derived from the Company distributions. Has anyone dealt with something similar?

He is an absentee owner and he figures he's just taking equity distributions / loans. I can't seem to get a good answer about how the company was initially capitalized and that gives me pause as well.

To make me more suspicious is that he has some carry-forward losses from two prior companies. (I'm assuming he did something similar for those companies.)

See Sec 1368 for how distributions are taxed. It doesn't sound like you have enough information to come to any conclusions. Is he able/willing to provide you with info? If not, run, don't walk, away.

Where is the cash coming from??? cash available for distributions must be either income, owners contributions or liabilities on the balance sheet.

I guess my original thoughts and line of questioning is in-line with what you are advising...

Basically I need to sort out how the company was capitalized, if the distributions are in excess of his at-risk basis then they should be treated as "as gain from the sale or exchange of property".

I've never had a client with such a transaction. Where do those excess distributions (treated as a gain on sale of property) flow through as income? Do they end up on Schedule D?

I guess my original thoughts and line of questioning is in-line with what you are advising...

Basically I need to sort out how the company was capitalized, if the distributions are in excess of his at-risk basis then they should be treated as "as gain from the sale or exchange of property".

I've never had a client with such a transaction. Where do those excess distributions (treated as a gain on sale of property) flow through as income? Do they end up on Schedule D?

Yes, long term capital gain (unless he owned the stock less than a year) but the question looks bigger than that. If the S corporation shows no income where does the cash come from? And how did the loss carryovers from "prior companies" arise? If they are from passive activities why weren't they taken when the activity was disposed of?

I guess my original thoughts and line of questioning is in-line with what you are advising...

Basically I need to sort out how the company was capitalized, if the distributions are in excess of his at-risk basis then they should be treated as "as gain from the sale or exchange of property".

I've never had a client with such a transaction. Where do those excess distributions (treated as a gain on sale of property) flow through as income? Do they end up on Schedule D?

I have been a CPA 30 years and have never done that. I show it as a loan on the balance sheet, charge interest and overtime the loan MUST be paid back. if the company folds, then the the client picks up income. Yes.... the letter of the law says pick it up as cap gain but I have never done that, and have only seen it done once or twice and I have worked for the big 4 and Other quality firms. In the end..he will pay the tax.

For example, a client this year borrowed 200K on a credit line to his business. he took the money and bought a property personally. It don’t like it but it happened. His balance sheet shows a loan to the bank and a loan to him. Theninterest expense on the loan is NOT deducted as I put that same amount on his schedule B.

There's a lot here. Where to begin. Yes, as others have wondered, where's the money coming from? Corp debts? Accumulated earnings? It must be one. 2. You alone should be the one who 'distributes' money. Book his monies taken as s/h loans until you get to year end and THEN you determine what's what based on profits and other factors. 3. If you have reason to believe that those advances can be repaid from future profits, then book a note and do as SouthPark says. Or if it's coming from accumulated earnings, then book the distribution from AAA. You control much of this.

Basically I need to sort out how the company was capitalized, if the distributions are in excess of his at-risk basis then they should be treated as "as gain from the sale or exchange of property".

Your terminology isn’t right…(i.e. “at risk basis”). The normal basis rules are applied before the at risk rules.

Key words in Post #3 were “on the balance sheet.”

Sure sounds like Balance Sheet is an alien concept in this thread, given the various and sundry accounting pieces you’ve tossed out: distributions, capitalization, operating income, etc.

If you’re working on 2018, the first thing you do is nail down the 12/31/17 Balance Sheet based on the taxpayer’s method of accounting. Look at the 2017 F1120S, Schedule L for starters. If the 1120S was prepared by some low level accountant and Schedule L was not presented, you’ll have to figure it out. Once you have an opening Balance Sheet, you move forward with the current year accounting, month by month. Eventually, you’ll arrive at financial statements for the entire year and you’ll precisely know how these distributions are to be handled, as per Post #2. Good luck and Godspeed.

If the 1120S was prepared by some low level accountant and Schedule L was not presented

Or maybe even if it was prepared by a high level accountant. I asked a respected tax instructor recently about that very thing, she said that when a Schedule L is not required with the return she doesn't file it, even though it is indeed completed and kept with the taxpayer records -- just not sent to IRS.

I’m obviously talking about the copy given to the client…

What you need is a basis schedule. Did previous accountant prepare one? Was one attached to last year's K-1, or tax return? If not, you will need to prepare one, which will be no fun if you have to go back a lot of years. Any distributions taken out in excess of basis is reported as a capital gain on individual's tax return, schedule D. As mentioned above, if individual intends to pay the money back, you could reclassify the distributions as a loan.

Thanks. Some great advice offered above.

To be clear, I am just his tax accountant and the client doesn't expect to pay for me to delve into his bookkeeping and prepare new financial statements. I need to work with what he has given me and what he discloses.

As for the distributions, I don't like the idea of keeping distributions in excess of basis as merely a loan to him because it just leaves the issue hanging out there. If it wasn't a formal loan with proper documentation, I think we just deal with it this year.

He still hasn't filed for 2017, so that is what I'm working on. However, for prior years, he has had these companies with carryforward losses (though he's exhausted any basis), so while they have no real current year effect do I need to delve deeper on those?

You need to scrap the "I'm just his tax accountant" thinking. If you're on this, then you have to do what you have to do, which is dig in enough to at least answer the questions we've posed. Those are minimum requirements! You lead him, not him lead you.

You need to scrap the "I'm just his tax accountant" thinking. If you're on this, then you have to do what you have to do, which is dig in enough to at least answer the questions we've posed. Those are minimum requirements! You lead him, not him lead you.

Agreed. Like I said, some great advice given. He needs to answer some questions about his financial statements and where the funds came from to establish his basis, whether there were any documented loans to him, etc. Nonetheless, I'm not preparing financial statements nor auditing his representations.

Thank you.

Your terminology isn’t right…(i.e. “at risk basis”).

Sure sounds like Balance Sheet is an alien concept in this thread, given the various and sundry accounting pieces you’ve tossed out: distributions, capitalization, operating income, etc.

Yeah, I was lazy with my verbiage. I was posting based on my memory of the taxpayer's situation and my fuzzy memory of details lead to fuzzy verbiage.

Your advice is well taken though, an accurate balance sheet for current and past years should answer most the questions.

Basis. You need to go back and properly calculate basis. It's the only way to determine how to report the distributions. He should pay you for your time. There's no other way. Software will help if you recreate the prior returns. I'd walk away too if you can't get the prior years, if you do get them perhaps you'll find one that was prepared with correct basis, start from there. Personally, I don't like the "loan idea"... a little late for creating a valid loan. Seaside has it right.

Where did the IRS get the cockamamie idea that they're doing us a favor by not requiring Schedule L under some conditions? They're not. Just my unsolicited observation.