S corp negative retained earnings impact on shareholder taxes

This doesn't sound right based on what you've described. As an S corporation shareholder, you should be reporting your share of the business's income or losses on your personal return, but negative retained earnings alone don't trigger capital gains. When an S corp has losses, those losses pass through to shareholders and reduce your basis in the S corp stock. Your basis starts with your initial investment, increases with income and additional capital contributions, and decreases with losses and distributions. You can only deduct losses to the extent you have basis. If you took distributions that exceeded your adjusted basis, then yes, that excess could be treated as capital gains. But if you're just getting back some of your initial investment while you have losses, that shouldn't trigger capital gains as long as the distribution doesn't exceed your remaining basis. I'd recommend asking your tax preparer to specifically explain which code section they're referring to and why they believe capital gains apply in your situation. It sounds like there might be a misunderstanding about the nature of the distributions or your remaining basis.

I was in a similar situation last year and found https://taxr.ai super helpful for understanding S corp basis calculations. My accountant was giving me conflicting information about how distributions would be treated after we'd had significant startup losses. I uploaded our operating agreement, K-1s, and some emails with our accountant to taxr.ai and got a detailed analysis that showed there was nothing in the tax code that supported treating our return of capital as taxable when we still had sufficient debt basis. Turns out my accountant was mixing up C corp and S corp rules. The site helped me understand exactly how my basis was calculated and what documentation I needed to support my position. I'd definitely recommend checking it out if you're getting advice that doesn't seem right.

Just wanted to follow up - I tried taxr.ai after seeing this thread and it was exactly what I needed. I uploaded my K-1s from the past two years, our operating agreement, and a summary of loans I'd made to my S corp. The analysis confirmed what I suspected - that I had sufficient debt basis even though my stock basis was zero, which meant I could still deduct losses and wouldn't have to treat limited withdrawals as capital gains. They provided specific citations to tax code sections and court cases that supported this position. I shared the report with my CPA when he returned, and he actually thanked me for finding this resource since it helped him understand some nuances of S corp basis calculations that he wasn't totally clear on. Definitely worth it if you're getting contradictory advice.

I've had nothing but frustration trying to get clarification from the IRS about S corp basis issues. Spent literal HOURS on hold trying to get someone who could explain the rules around negative retained earnings and shareholder loans. Finally discovered https://claimyr.com which got me through to an actual IRS agent in about 15 minutes. They have this system where they wait on hold for you and call when an agent is on the line. There's a demo video at https://youtu.be/_kiP6q8DX5c that shows how it works. The agent was able to confirm that negative retained earnings alone don't trigger capital gains and pointed me to the specific IRS publications that explain basis calculations for S corporation shareholders. Saved me days of frustration and probably prevented me from overpaying thousands in taxes.

I have to eat my words about Claimyr. After posting my skeptical comment, I decided to try it myself since I've been trying to reach someone at the IRS about a different S corp issue for weeks. I was connected to an IRS representative in about 20 minutes (they estimated 25, so pretty accurate). The agent clarified that distributions in excess of basis are indeed treated as capital gains, but also explained that if I had made loans to my S corp, I might have "debt basis" even if my "stock basis" was zero. This was a game-changer for my situation because I had been financing some operations with shareholder loans. The agent directed me to Form 8082 which I can use to take a position contrary to what's reported on my K-1 if I believe it's incorrect. Would never have gotten this information without actually speaking to someone, so I'm grateful for the suggestion.

This sounds like a basis issue. Here's what's probably happening: 1. Your initial investment gave you a starting basis in your S corp stock 2. The 2023 losses reduced that basis 3. The 2024 losses reduced it further 4. You took money out (distributions) If your basis went negative because distributions + losses > initial investment + any income, then the excess distribution is treated as capital gain. Example: You invest $50K, lose $30K in 2023, lose $15K in 2024, and take out $10K. Your basis calculation would be: $50K - $30K - $15K - $10K = -$5K. That $5K would be capital gain. Did you also make any loans to the business? Those can create "debt basis" which is separate from your "stock basis" and can help avoid this issue.

Has anyone else noticed that a lot of accountants seem confused about S corp basis calculations? I've had three different CPAs give me three different answers about how to handle distributions when we've had prior losses.

I'd definitely recommend getting a second opinion on this. Based on what you've described, it sounds like your tax preparer might be misunderstanding something about your situation. The key issue is tracking your basis correctly. Your basis in the S corp stock starts with your initial investment, gets reduced by your share of losses, gets reduced by distributions you receive, and gets increased by additional capital contributions or your share of income. If you made additional capital contributions during 2024 (like the $75K you mentioned in another comment), those should increase your basis and likely eliminate any capital gains treatment on your distributions. Make sure your tax preparer has accounted for all capital contributions, not just your original investment. Also, if you've made any loans to the S corp (even informal ones where you paid business expenses out of pocket), those create "debt basis" which can help absorb losses and avoid capital gains on distributions. I'd suggest asking your tax preparer to show you the specific basis calculation they're using. They should be able to walk through: starting basis + capital contributions + income - losses - distributions = ending basis. If that number goes negative, only the negative portion would be capital gains. Don't just accept their conclusion without understanding the math behind it - this is a common area where even experienced preparers make mistakes.