Passive or Nonpassive Trade or Business considerations would be needed in determination if there is any limitation for loss offset.
This explanations and examples - while related to Dealership type of business - may provide some lights on the IRS interpretation - http://www.irs.gov/businesses/corporations/article/0,,id=137740,00.html
The basis that shareholder has in the corporation is his/her contribution (either money or property). On the schedule would be reported if shares were sold. If capital gains distribution is automatically reinvested, the reinvested amount is added to the basis.
It sounds as if there is material participation and the activity is not by definition passive like residential rental real estate.
You can use the same decision tree that the IRS uses in an audit. If the answer to any one of the questions below is yes, losses are excepted from the passive loss limitations because he does materially participate. That means it is nonpassive and yes materially participates so losses are generally fully deductible.
If answer to all the above tests is no, the taxpayer does not materially participate. The loss is passive and not deductible except against passive income.
I hope this helps for deciding material participation..
Distributions and basis is another topic entirely than material participation and passive activity.
There are not a capital gains distributions from an S corporation. Capital gain distributions are given from mutual funds that sell part of the portfolio during the year.
You can get distributions from an S corporation; but these are generally distributions of the profit of the S corporation or return of the contributions that the shareholder made to the corporation.
In the tax software you need to be sure that you enter all of the contributions of cash and property that were made (and all of the prior year income that was reported as taxable) as part of the basis of the shareholder. Some software has a separate section to enter these contributions and prior earnings that were taxable. Often it will refer to the shareholder basis.
If you distribute more than you have previously invested in the S corporation and more than you have previously reported as income from the S corporation you will have a capital gain. That capital gain does go on Schedule D.
Make sure that the amount of distributions this year are more than the contributions and prior earnings that were subject to tax and if that makes sense then you will have an entry on Schedule D; but as you mentioned this is not the usual case.
I hope this helps for determining if there is a capital gain that exceeds the contributions and prior taxable earnings.
Where did the money to run the corporation come from?
Are you saying he only worked and did not contribute money?
Are you counting the reimbursements as distributions?
Can the distributions that are more than the earnings for this year be considerd a loan from the corporation to him (the shareholder) ? Would he pay them back in the future (or have less of a distribution of future profits)?
Have you considered using a tax pracititoner to get the first return done properly as an investment in not having to correct it later?
Thanks for the information.
If there was indeed reimbursement for all monies paid for expenses and also amounts were paid (over and above the wages); then those amounts will be distributions that could be capital gain to the extent that the distribution is more than the shareholder's part of the earnings for the year.
For example, if there was 150K of earnings and 60K was distributed to each 1/3 owner there would be 10K of capital gain reported by the shareholder. Earnings of 150K/3 was 50K and 60K - 50K = 10K of gain due to the excess of money paid over the share of the earnings.
At Shareholder's Basis in S Corporation is an example of a worksheet to compute basis for the tax year.
I hope this helps to clarify for you.