Discussion:S Corp: Excess Distributions as Capital Gains.

1) Code Sec 1368(b)(2) states that distributions in excess of basis "shall be treated as gain from the sale or exchange of property." I take it that the phrasing "shall be treated as" does not mean that a sell of stock actually occurred. In other words, claim the excess distribution on Sch D with zero basis and write something like "excess distrib from SCorp-name" as discussed in this thread Discussion:How do I enter excess distributions as a capital gain?. This transaction does not change the number of shares owned by the shareholder. Is this assumption correct?

2) Does reporting a gain on a stock that is not actually sold have a future effect on the stock? What happens when the shareholder sells his stock in the future? My gut feeling is to ignore the previously reported gain from the excess distribution and use the current basis/proceeds in determining the outcome of the transaction.

3) Bonus Lacerte User Question

When preparing form 1120s, the distribution in excess of basis will come up as a critical diagnostic error in Lacerte, and the excess distribution will be a reduction of retained earnings along with the distribution from AAA. The error should be documented but will need to be overridden in order to process the return. I think the error is just there to let the preparer know to pass this information along to the shareholder.

When preparing form 1040, the excess distribution part of Box 16 D, on form K-1. The excess needs to be manually entered on Schedule D, and also on the shareholder basis schedule as an "other current year increase to basis" since the program is reducing the shareholder's basis by the total amount of the distributions (including distributions not in excess of basis).

Has anyone else had to complete this transaction in Lacerte?

Thanks again for any input.

I agree that the excess distribution is not formally reported on form 10020s. Lacerte seems to identify it though. I prepared an 1120 "test" return earlier in Lacerte to see what would happen and the program recorded it as follows:

First it comes up as an error that reads "the amount of distributions on Schedule K1, line 16d is greater than the total net balance available for distribution in all of the schedule M-2 accounts by $73,781. The amount of excess distributions has reduced the ending balance of retained earnings on Schedule L, line 24."

Then a reconciliation statement is prepared

Reconciliation of Retained Earnings

Beginning Retained Earnings (Schedule L, Line 24)... 285

Net Income Per Books (Schedule M-1, Line 1)... 170,617

Distributions:

Accumulated Adjustments Account... -170,902

Distributions in excess of Sch. M-2/E&P accounts ... -73,781

Ending Retained Earnings (Schedule L, Line 24)... -73,781

Did you find a solution/response to your question above? I've got the same issue here and it seems you can override and force the "distributions from AAA Not limited to balance" -- it clears the diagnostic reducing AAA for the excess distrib. I'm assuming the impact of the excess distribution is a direct reduction to RE on Schedule L which is eactly how Lacerte is handling it. It would then appear that the book entry is a debit to RE and credit to distributions in order to tie out to the tax return. Does this sound correct to you?

Thanks.

Distributions cannot be used to create or increase a negative balance in AAA. In any event, if the corporation has always been an S corporation, the AAA account is meaningless.

SoCal, to address your question #2 in your OP: The gain recognized for distributions in XS of basis simply restores basis to zero. This would all be accounted for in your tracking of basis. Hopefully that helps.

By the way in my first post I meant to say "The error should be documented but will NOT need to be overridden in order to process the return."

I still can't figure out how to edit my posts.