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Tax treatment when S-Corp sole owner withdraws more than AAA account

Michael Davidson's Profile

If an S-corp owner withdraws more out of the business than s/he has in current or accumulated profits, and doesn't account for it as a loan, is it then appropriate to account for the excess as a long-term capital gain?  I think it's appropriate but would welcome other insights.

 

Thanks.

 

Answers

Jay Holmes
Title: CPA, Partner
Company: Holmes and Larson, PLLC
(CPA, Partner, Holmes and Larson, PLLC) |

To note - just because their AAA account is zero, does not mean they have a taxable event. The taxable event is triggered when their distributions are in excess of their stock basis (mentioned by Nancy). Their (all owners) stock basis should equal AAA + APIC + Capital Stock - any distributions against their stock basis.

Michael Davidson
Title: Founder & Principal
Company: Business Recovery & Revival Services, LL..
(Founder & Principal, Business Recovery & Revival Services, LLC) |

Thanks for the prompt answers, Nancy and Jay. I guess I was on the right track, especially since there is no basis in the stock right now. As to Nancy's question, best I know of is that the S-Corp used its bank availability and strict cash flow management to fund the distribution(s). As a turnaround and finance guy, hearing this makes me break out in hives!! But in this case the owners believe that they are in a temporary downturn and will make it back soon enough. Hope they are right.

But all this led to another question:

If the opening AAA is negative (from nondeductible losses), for example ($10,000), and the S-corp makes a pass-through profit of $5,000 in the year, and
the owners distribute $20,000 in cash to themselves during the year, what is the flow through (again, no basis in the stock)? I would assume that the K-1's would show the $5,000 and the $20,000, but for the personal returns they would show no flow through income and a capital gain of ???.

Thanks again.

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