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Excess Distributions over Basis, S-Corp Bookkeeping


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Client is a new single owner S-corp.  Profit was $1k this year.  Company took out a $56k loan from the bank.  Then proceeded to issue a stockholder draw to the owner for $56k.  Aside from simply reclassifying the $56k draw as a loan to the shareholder, lets say that isn't done.  

Then owner has overdrawn their basis by $55k and he's got a $55k LTCG on his personal return. 

But how is the $56k draw account closed out for the year?  I usually close out all draws to AAA, but since AAA can't go negative by distributions, only losses, what is it closed to? 

Meaning, in my YE closing entries:

DEBIT: AAA $1,000

DEBIT: ????  $55,000

CREDIT:  Stockholder Draws  $56,000

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The excess distribution will be closed out to retained earnings that will create a negative balance.  That will happen when the shareholder has used up stock basis. 

Some others here may also suggest creating a shareholder loan, but I'd caution that this should be fully documented and make sure that is the shareholder's INTENT, including paying it back with interest that at least meets the current AFR.  

Also talk to your client about not using the S corp as his or her personal checkbook.

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On 2/21/2021 at 10:10 AM, jklcpa said:

The excess distribution will be closed out to retained earnings that will create a negative balance.  That will happen when the shareholder has used up stock basis. 

Some others here may also suggest creating a shareholder loan, but I'd caution that this should be fully documented and make sure that is the shareholder's INTENT, including paying it back with interest that at least meets the current AFR.  

Also talk to your client about not using the S corp as his or her personal checkbook.

Thank you!  I constantly remind and borderline harass my clients about keeping their personal and business finances separate.   

In the follow year, assuming it's profitable, do I net it against the negative R/E first?  Then once all the negative R/E is exhausted, proceed as usual with the AAA?

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13 hours ago, GGRNY said:

In the follow year, assuming it's profitable, do I net it against the negative R/E first?  Then once all the negative R/E is exhausted, proceed as usual with the AAA?

You should hire an accountant or a really good bookkeeper. Your questions indicate that you're in over your head.

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Basic bookkeeping:

Prior year net income (loss) always closes to retained earnings. QuickBooks and other accounting software does this automatically.

I close total prior year distributions as of 1/1 each year to retained earnings so the books match the tax return retained earnings, and I can see that the books match the tax return beginning balance sheet without entering both numbers into a calculator. This also makes distributions start at zero for the new year.

I know some accountants who don't close S corp distributions each year and they do a comparative balance sheet to see current year distributions but I'd rather see that beginning RE is correct at a glance.

For partnerships, I also close partner capital contributions the same way I close distributions, except to each partner's separate capital account.

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3 hours ago, Abby Normal said:

Basic bookkeeping:

Prior year net income (loss) always closes to retained earnings. QuickBooks and other accounting software does this automatically.

I close total prior year distributions as of 1/1 each year to retained earnings so the books match the tax return retained earnings, and I can see that the books match the tax return beginning balance sheet without entering both numbers into a calculator. This also makes distributions start at zero for the new year.

The above order of operations is exactly how I close books. The only difference is I have always changed the name "Retained Earnings" to AAA in Sub-S client's Quickbooks as I found it easier to discuss AAA & basis monitoring with this change.

Given I've never had a client overdraw their basis, I wondered how others handled the bookkeeping of that negative balance.    

jklcpa, Thank you for your time and considerate replies.  

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I've spent every free moment of the last few days researching this thread's info.  I come from a family of accountants and we always maintain books on a tax basis. Our clients are small mom and pop businesses and reporting books that mirror the tax return just makes explaining things so much easier.  Quite honestly, I never knew S-corp bookkeeping to be any other way.  In fact, my father adamantly followed the rule, "1120S Sch L R/E MUST = Schedule M-2."

I now know better thanks to the knowledgeable members of this forum and countless tax articles & publications I've read since.   

For anyone reading this thread in the future with similar questions to the ones I had, there's another great ATX thread that I found extremely helpful in better understanding this concept and hope it helps you too.  Thanks again ATX forum.  I'm humbled as usual. 

_________________________________

Testing my updated Sub-S books to tax understanding...

On 2/20/2021 at 10:12 PM, GGRNY said:

Client is a new single owner S-corp.  Profit was $1k this year.  Company took out a $56k loan from the bank.  Then proceeded to issue a stockholder draw to the owner for $56k.  Then owner has overdrawn their basis by $55k and he's got a $55k LTCG on his personal return. 

Using only the above details and pretending the profit was all kept in the bank.

Books Balance Sheet:

  • Bank Asset: $1,000
  • Loan Liability: $56,000
  • R/E: -$55,000

Tax Return:

  • Sch L R/E: -$55,000
  • M-2 AAA: 0
  • K-1: Box 1: $1,000
  • Box 16, Code 😧 $56,000  
  • Basis monitoring is done at the shareholder level so it's the responsibility of the SH to report a $1k profit on the schedule E, page 2 and a $55k capital gain for overdrawing their basis on Sch D. 
  • SH current basis in the corp: $0

Going forward, there will now be a permanent difference between R/E & AAA. 

Correct? (fingers crossed)

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