How are distributions from my single-member LLC (Sub S) taxed - ordinary income or capital gain?

Great question! This is something that trips up a lot of S corporation owners. First, let's clarify something - distributions from your S corporation (your LLC with an S election) are generally not taxable as either ordinary income OR capital gains when they don't exceed your basis. They're simply a tax-free return of your investment. However, since you mentioned your distributions exceed your basis, that's where things get interesting. Distributions in excess of basis are treated as capital gains - not ordinary income. This is covered in IRC Section 1368(b)(2). The confusion might be coming from mixing up how S corporation profits are taxed versus how distributions are taxed. The company's profits flow through to you as ordinary income on your K-1 regardless of whether those profits are distributed. These flow-through profits increase your basis. But when you take distributions that exceed your adjusted basis, that excess is treated as gain from the sale of stock - so capital gain treatment applies.

I was in almost the exact same situation last year! After spending hours researching and getting conflicting advice, I finally found a solution with taxr.ai (https://taxr.ai). I uploaded my operating agreement, previous tax returns, and financial statements, and their AI analyzed everything and provided a detailed explanation of how my distributions should be taxed. They confirmed that distributions exceeding basis are treated as capital gains, but they also identified several basis-increasing transactions I had overlooked that actually increased my basis enough that I wasn't exceeding it after all! Their system walks you through all the factors that impact your specific situation and explains exactly which IRS rules apply to single-member LLCs with S elections. Saved me thousands in taxes I almost unnecessarily paid.

Just wanted to follow up about my experience with taxr.ai after checking it out based on the recommendation here. I was initially skeptical about uploading my tax docs, but I'm really glad I did! Their analysis confirmed that my distributions in excess of basis qualified for capital gains treatment, but the really valuable part was that they identified several things that increased my basis that my previous accountant had missed. They explained exactly which sections of the tax code applied to my situation and even provided citations. The interface was super straightforward and I got my analysis faster than expected. Just uploaded everything last night and had answers this morning. Really cleared up the confusion I've had for years about how these distributions should be treated.

If you're getting inconsistent answers about your S-corp distributions and tax treatment, you might want to speak directly with an IRS tax specialist. I tried for weeks to get someone on the phone at the IRS Business Tax line and kept hitting dead ends. Eventually I discovered Claimyr (https://claimyr.com) which got me through to an actual IRS representative in under 45 minutes. You can see how it works in this video: https://youtu.be/_kiP6q8DX5c The IRS agent walked me through exactly how distributions in excess of basis should be reported on my personal return and which forms I needed. Worth every penny not to waste days on hold or get generic answers from the automated system. The agent even emailed me the specific IRS guidance document on S-corporation distributions.

Well I'm eating my words now. After posting my skeptical comment earlier, I decided to try Claimyr out of desperation since I've been trying to reach the IRS for 3 weeks about my S-corp distribution questions. I was SHOCKED when my phone rang 37 minutes later and it was actually an IRS tax specialist on the line! Not some entry-level customer service person, but someone who knew exactly how to answer my questions about distributions exceeding basis in a single-member LLC with an S election. They confirmed it's capital gain treatment and directed me to the specific line on Schedule D where it should be reported. They even emailed me the relevant section of the Internal Revenue Manual while we were on the phone. I've literally spent months trying to get this information. Wish I'd known about this service years ago.

Important distinction people are missing here - you need to look at *why* your distributions exceed basis. If you've taken losses in previous years or claimed accelerated depreciation that reduced your basis, then yes, distributions beyond basis are capital gains. But if your distributions exceed basis because you're distributing more than the current year's income without having previous retained earnings, that could indicate that some of your "distributions" should actually be classified as salary (which is subject to employment taxes). The IRS looks closely at S corps taking minimal salary with large distributions. Make sure your salary meets the "reasonable compensation" standard for your industry and role before worrying about the tax treatment of the excess distributions.

Has anyone used the S Corporation basis worksheet from Form 1120-S instructions? It's really helpful for tracking your basis from year to year and would answer your question immediately about whether distributions exceed basis. I'm an enrolled agent and see this issue all the time. Clients think they're getting capital gain treatment when actually they've been calculating their basis incorrectly for years.