Confused about S Corp Distribution reporting - Schedule M-2 and SK-1 questions

You're asking excellent questions about S Corp distributions and basis tracking, which can be confusing even for experienced business owners. When a shareholder withdraws money from an S Corp, it's important to understand how it's characterized. A withdrawal of previously contributed capital is indeed considered a distribution, but it's treated differently than distributions of earnings. For your first question: Yes, the $25k withdrawal should be reported on Schedule M-2, Line 7, but it first reduces the AAA (Accumulated Adjustments Account) balance, which is where your previously taxed income is tracked. Since you only have $1.3k there, only that portion would go in column b. The remaining $23.7k would reduce other components of equity, specifically the capital account. This doesn't automatically trigger capital gains. Capital gains only occur when distributions exceed the shareholder's total basis. The shareholder's basis includes their capital contributions, so they can generally receive their contributed capital back tax-free as long as they have sufficient basis. For your second question: Yes, all distributions, including returns of capital, should be reported on Line 16d of Schedule K-1 (not SK-1). This is crucial for properly tracking the shareholder's basis.

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I was super skeptical about https://taxr.ai when I first heard about it, but I decided to give it a try after spending way too much time trying to figure out how to handle S corp distributions correctly. My situation was even more complex with multiple shareholders and different classes of stock. What really impressed me was how it identified that I had been incorrectly tracking basis for years! Turns out I was mixing up the AAA account with shareholder basis, which are related but definitely not the same thing. It showed exactly how to correct my previous mistakes on the Schedule M-2 and K-1s. The step-by-step guidance on handling return of capital vs. income distributions saved me from potentially serious tax issues. Now I understand exactly how to report capital returns on Schedule M-2 and how it flows through to the K-1. Wish I'd found this years ago!

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Little trick I learned from my accountant for tracking S Corp distributions: maintain a separate spreadsheet that tracks each shareholder's basis components (capital contributions, loan basis, income/loss allocations, and distributions). For the original question, the $25k withdrawal reduces the shareholder's capital account first, not the AAA. The AAA is a corporate-level account that tracks undistributed earnings that have been taxed to shareholders, not capital contributions. On Schedule M-2, you'd only report the $1.3k of AAA being distributed in column b. The remaining $23.7k would reduce the Other Adjustments Account (OAA), not the AAA. This won't trigger capital gains since the shareholder still has $27k ($52k - $25k) of capital contribution basis left.

Anyone know if there's a specific form I need to use to inform shareholders about how distributions affect their basis? My partner is freaking out thinking he'll owe taxes on the $30k we distributed from our S-Corp this year even though it's all return of capital.

I think there might be some confusion in the thread about how distributions are ordered and reported. Let me clarify the proper sequence for S Corp distributions: When an S Corp makes a distribution, it comes out in this specific order: 1. First from AAA (Accumulated Adjustments Account) - this is previously taxed income 2. Then from PTI (Previously Taxed Income) if you have any from pre-1983 3. Then from paid-in capital/capital contributions 4. Finally, anything beyond that would be taxable gain For your $25k distribution with only $1.3k in AAA: - $1.3k reduces AAA and goes in Schedule M-2 Line 7, column (b) - The remaining $23.7k reduces your capital account and goes in Schedule M-2 Line 7, column (c) "Other adjustments account" This is NOT the same as the OAA that some mentioned - that's a different account entirely. The capital account reduction represents the return of your partner's original $52k contribution. On the K-1, the full $25k gets reported on Line 16d as a distribution. Your partner won't owe any tax on this since it's just getting back money he originally put in, and it reduces his stock basis accordingly. The key thing to remember is that returning capital contributions is generally tax-free as long as it doesn't exceed the shareholder's total basis in their S Corp stock.

This is a really common confusion with S Corp distributions! The key distinction you need to understand is the difference between the corporate-level accounts (like AAA) and individual shareholder basis. Your partner's $25k withdrawal is indeed a distribution, but here's how it should be handled: **Schedule M-2 Reporting:** - Only $1.3k would be reported on Line 7 column (b) as a distribution from AAA - The remaining $23.7k represents a return of capital contribution, which reduces the capital account on your balance sheet but doesn't flow through the M-2 in the same way **No Capital Gains Issue:** Your instinct is correct - this shouldn't trigger capital gains! Since your partner contributed $52k originally, withdrawing $25k is simply getting back part of his original investment. He still has $27k of capital contribution basis remaining. **K-1 Reporting:** Yes, report the full $25k on Schedule K-1 Line 16d as a distribution. This reduces your partner's stock basis but isn't immediately taxable since it's within his basis. **Pro tip:** Keep a separate basis tracking worksheet for each shareholder showing capital contributions, allocated income/losses, and distributions. This makes it much easier to determine the tax treatment of future distributions. The ordering rules for S Corp distributions can be tricky, but returning capital contributions is generally the most straightforward situation. You're doing the right thing by getting this clarified before filing!