What is happening to that debt?

The debt is money the shareholder loaned to the company. The company did not do well and lost money. There is no money to pay the shareholder back.

In other words, the debt was cancelled.

Yes. But if I add the amount to the tax return income as Cancelled Debt Income, the amount goes on the K-1 and the Shareholder not only has put money into this business as a loan that he is not going to get back, but he gets taxed on it as well. 

Perhaps the shareholder decides that this was contributed capital and not a loan?

The contributed money over the past two years has been called a loan. The previous K-1s have the loan balances. I don't know how to change that.

Also, since this is an LLC, there is no Capital Stock. Would that also mean there is no Paid in Capital?

Any other ideas? I appreciate your help!

"has been called a loan"

Have there been any payments? Was any interest expense/income reported? Any activity on this at all? Are there other shareholders? Was this carried from the LLC into the S Corp?

No repayments or interest paid on the money loaned to the corporation. Current year is the third year of existence. They kept putting more and more money in and the corporation never did well, so could not pay it back. So at the end, the loan balance and the negative Retained earnings are the same amount.

There are two Members. He and his wife. 50/50 owners.

Loans to corporation occurred while an S Corporation.

Is there a documented debt agreement? Imputed interest?

Otherwise, you might read how this was worded by @sjrcpa 

"Perhaps the shareholder decides that this was contributed capital and not a loan?"

Note that present tense.

No debt agreement or imputed interest.

I am not sure I can just start calling it Contributed Capital in year three. The contributed money over the past two years has been called a loan. The previous K-1s have the loan balances. I don't know how to change that.

Also, since this is an LLC, there is no Capital Stock. Would that also mean there is no Paid in Capital?

It is not unheard of for a loan to be converted to equity. LLCs have contributed capital.

Okay. In ProSeries, I went to the Basis Info Wks and entered the ending loan balance as "Stock Contribution" and as a "Loan repayment to shareholders" so the ending loan balance on the K-1s will be zero.

On the Balance Sheet, the loan balance is now showing as Additional Paid In Capital. I also still have the negative Retained earnings for the same amount. How do I zero out the Balance Sheet negative Retained Earnings balance? 

I think I solved my problem. I couldn't get the Retained earnings to go away on the Balance Sheet. I was using the Automated Schedule M-2/Retained earnings Worksheet. When I checked "No" to that option on the 1120S page 5, I could then just delete the Retained Earnings balance and enter the Additional Paid In Capital on the M-2 - Other Additions.

Everything looks good now, even the Basis statements.

Thanks for all the help!

Why shouldn't retained earnings stay negative and just be offset by an equal positive entry to paid in capital? The business lost money and the owner covered it.

"The business lost money and the owner covered it."

The considerations for this topic, as originally asked, are:

Final return

Listed as Shareholder Loan

So...

Is it really a loan, with a Note Payable, interest, payment terms? Or is it really just more capital? This person had a loan on the books. You can't end with that condition. You have to deal with it.

Is it the Final return, and you intend to report it as forgiven debt instead of closing out equity?

Is there more than one shareholder?

Details matter.

Since details matter, you should have been more attentive.

I was responding to:

"Okay. In ProSeries, I went to the Basis Info Wks and entered the ending loan balance as "Stock Contribution" and as a "Loan repayment to shareholders" so the ending loan balance on the K-1s will be zero.

On the Balance Sheet, the loan balance is now showing as Additional Paid In Capital. I also still have the negative Retained earnings for the same amount. How do I zero out the Balance Sheet negative Retained Earnings balance?"