Calculating Shareholder Basis in S-Corporation

  • Thread starter CHANGE USERNAME TO westes
  • Start date

C

CHANGE USERNAME TO westes

I have some questions regarding how "basis" is calculated
for a shareholder in an S-Corporation.

First, I want to make sure I understand the whole concept.
As best I can tell, government is using this concept of
basis to make sure that you cannot use losses in a
corporation to offset other income in excess of the amount
that you have invested in the corporation, or gained in the
form of net operating gains of the corporation. Is this
the basic idea?

As I understand it, positive net income in the corporation
increases basis, and negative net income reduces basis.
What is confusing me is how distributions factor into this,
and more specifically how specific types of distributions
factor in.

What, for example, if an S-Corporation makes $100K net
income, on which $40K federal tax is due. The
S-Corporation distributes $40K to the sole shareholder in
order to allow the shareholder to pay the tax bill that is
passed to the shareholder on the K-1. (S-Corporations pay
no federal tax directly.) In this kind of distribution,
is the shareholder's basis reduced by $40K? So the basis
in this case represents the net positive cash flow, after
taxes, of $100K - $40K = $60K? How does the shareholder
report this $40K distribution so as to not be taxed on this
as separate income?

What about the case where the S-Corporation distributes $40K
to the shareholder and claims this as a corporate expense?
I assume the shareholder must treat this as a taxable
dividend? How does it show on the Schedule K-1? Say in
this case that corporate net income is $60K, on which $24K
federal tax is due. What did the two distributions and net
income do to the shareholder's basis in the S-Corporation?
In this case, is it $60K - $24K - $40K = ( -$4K ), leaving
the shareholder a negative basis?

I assume that if basis goes to zero, or becomes negative,
that any net operating losses in the corporation accumulate
and can only be written off against future gains in the same
corporation?
 
Ad

Advertisements

P

Phoebe Roberts, EA

CHANGE said:
I have some questions regarding how "basis" is calculated
for a shareholder in an S-Corporation.

First, I want to make sure I understand the whole concept.
You could probably take 8 hours of CPE and not understand
the whole concept. The finer points of basis are
complicated.
you cannot use losses in a
corporation to offset other income in excess of the amount
that you have invested in the corporation, or gained in the
form of net operating gains of the corporation. Is this
the basic idea?
More or less.
What, for example, if an S-Corporation makes $100K net
income, on which $40K federal tax is due. The
S-Corporation distributes $40K to the sole shareholder in
order to allow the shareholder to pay the tax bill that is
passed to the shareholder on the K-1. (S-Corporations pay
no federal tax directly.) In this kind of distribution,
is the shareholder's basis reduced by $40K? So the basis
in this case represents the net positive cash flow, after
taxes, of $100K - $40K = $60K?
Yes, assuming beginning basis was zero, there were no
non-deductible expenses, and the only activity was $100,000
of income and a $40,000 distribution.
How does the shareholder
report this $40K distribution so as to not be taxed on this
as separate income?
Distributions aren't reported by the shareholder. They go
on Line 20 of the K-1.
What about the case where the S-Corporation distributes $40K
to the shareholder and claims this as a corporate expense?
If it's an expense, then it's not a distribution. It might
be wages, or rent payments, or expense reimbursement, but
not a distribution. Distributions aren't deductible.
I assume the shareholder must treat this as a taxable
dividend? How does it show on the Schedule K-1?
In order to pay out a taxable dividend, the S-corporation
has to have been a C-corp with E&P at some point. Assuming
that's the case, there's still no expense deduction for the
corporation, because dividends aren't deductible. It
doesn't go on the K-1, it goes on a 1099-DIV. If you have
an S-corp with C-corp E&P and you're trying to do it
yourself, basis is the least of your worries.
this case that corporate net income is $60K, on which $24K
federal tax is due. What did the two distributions and net
income do to the shareholder's basis in the S-Corporation?
In this case, is it $60K - $24K - $40K = ( -$4K ), leaving
the shareholder a negative basis?
The amount of tax due is irrelevant; the corporation can
distribute (or not) for whatever reason or no reason. If
you have zero beginning basis, $60,000 of net income and
$64,000 of distributions, and no other adjustments to basis,
the shareholder has distributions in excess of basis of
$4,000. That $4,000 is taxable income to the shareholder
(capital gains with the same holding period as the S-corp
stock), and recognizing the gain brings basis up to zero.
Your basis can never go below zero.
I assume that if basis goes to zero, or becomes negative,
that any net operating losses in the corporation accumulate
and can only be written off against future gains in the same
corporation?
Zero basis isn't the same as an NOL; the phrase you're
looking for is "suspended losses." They get used up to the
extent you have basis, which could be from net income or
because you contributed cash to the business.

Basis is not a do-it-yourself project, and based on the
questions you're asking, you shouldn't be doing your own
1120S, either.

Phoebe :)
 
M

Mike Lewis

I have some questions regarding how "basis" is calculated
for a shareholder in an S-Corporation.

First, I want to make sure I understand the whole concept.
As best I can tell, government is using this concept of
basis to make sure that you cannot use losses in a
corporation to offset other income in excess of the amount
that you have invested in the corporation, or gained in the
form of net operating gains of the corporation. Is this
the basic idea?
Yes

As I understand it, positive net income in the corporation
increases basis, and negative net income reduces basis.
What is confusing me is how distributions factor into this,
and more specifically how specific types of distributions
factor in.

What, for example, if an S-Corporation makes $100K net
income, on which $40K federal tax is due. The
S-Corporation distributes $40K to the sole shareholder in
order to allow the shareholder to pay the tax bill that is
passed to the shareholder on the K-1. (S-Corporations pay
no federal tax directly.) In this kind of distribution,
is the shareholder's basis reduced by $40K? So the basis
in this case represents the net positive cash flow, after
taxes, of $100K - $40K = $60K? How does the shareholder
report this $40K distribution so as to not be taxed on this
as separate income?
You are correct that your basis increases by the net 60k
less any non-deductible expenses plus any non taxable
income.
What about the case where the S-Corporation distributes $40K
to the shareholder and claims this as a corporate expense?
This can only be treated as an expense if it is for a
legitimate business service you have provided....examples
would be a commission (in which case the S-corp should issue
you a 1099-MISC upon which you would pay both federal and SE
tax) or a salary (in which case you would get a W-2).
I assume the shareholder must treat this as a taxable
dividend? How does it show on the Schedule K-1? Say in
this case that corporate net income is $60K, on which $24K
federal tax is due. What did the two distributions and net
income do to the shareholder's basis in the S-Corporation?
In this case, is it $60K - $24K - $40K = ( -$4K ), leaving
the shareholder a negative basis?
Assuming the $60K is BEFORE deducting the EXPENSE, you would
have K-1 income of $20K. If you began the year with zero
basis (and there are no non-deductible expense, non-taxable
income) the excess distribution of $4K must be recognized as
taxable income. Basis in an S corp can't be reduced below
zero. If a distribution causes this, it is taxed. If you
have losses, they are simply "Suspended" until a later year
when you have S-Corp income, contribution by you or loan by
you (in writing) to offset it against. This would also be
the time that such losses could be used to reduce income on
your 1040.
I assume that if basis goes to zero, or becomes negative,
that any net operating losses in the corporation accumulate
and can only be written off against future gains in the same
corporation?
See above....

Mike Lewis, CPA
 
G

Gene E. Utterback, EA

CHANGE USERNAME TO westes said:
I have some questions regarding how "basis" is calculated
for a shareholder in an S-Corporation.

First, I want to make sure I understand the whole concept.
As best I can tell, government is using this concept of
basis to make sure that you cannot use losses in a
corporation to offset other income in excess of the amount
that you have invested in the corporation, or gained in the
form of net operating gains of the corporation. Is this
the basic idea?

As I understand it, positive net income in the corporation
increases basis, and negative net income reduces basis.
What is confusing me is how distributions factor into this,
and more specifically how specific types of distributions
factor in.

What, for example, if an S-Corporation makes $100K net
income, on which $40K federal tax is due. The
S-Corporation distributes $40K to the sole shareholder in
order to allow the shareholder to pay the tax bill that is
passed to the shareholder on the K-1. (S-Corporations pay
no federal tax directly.) In this kind of distribution,
is the shareholder's basis reduced by $40K? So the basis
in this case represents the net positive cash flow, after
taxes, of $100K - $40K = $60K? How does the shareholder
report this $40K distribution so as to not be taxed on this
as separate income?

What about the case where the S-Corporation distributes $40K
to the shareholder and claims this as a corporate expense?
I assume the shareholder must treat this as a taxable
dividend? How does it show on the Schedule K-1? Say in
this case that corporate net income is $60K, on which $24K
federal tax is due. What did the two distributions and net
income do to the shareholder's basis in the S-Corporation?
In this case, is it $60K - $24K - $40K = ( -$4K ), leaving
the shareholder a negative basis?

I assume that if basis goes to zero, or becomes negative,
that any net operating losses in the corporation accumulate
and can only be written off against future gains in the same
corporation?
You are confusing issues. Basis is relatively straight
forward, if you can stay focused. Basis is the calculated
value of what you have left of your investment. It has
nothing to do with taxes due, owed or paid - get these
thoughts out of your way and focus on what you have in the
investment. Let's use your example, ignoring any original
contributions or anything else:

S corporation has $100K net ordinary income - no other
income or expenses = your basis in your investment in this S
Corporation just increased by $100K

S corporation distributes $40K to the stockholder = your
basis in your investment in this S corporation just
decreased by $40K - your remaining basis is now $60K. It
matters not WHAT the distribution was for - get the idea of
your personal tax debt out of your way.

NOTE - taxpayer reports and pays tax on $100K as income from
the S corporation on their personal return.

Second Example - again using your numbers:

S corporation has $60K income and a deductible expense of
$40K, netting $20K ordinary income = basis now is $20K

The $40K is for a deductible expense. This might be salary
to a stockholder, it might be payment of rent, it might be
the fee for the preparation of the tax return. It matters
NOT what it was for as long as it qualifies as a deductible
expense. Dividend payments are NEVER deductible by any
corporation and S corporations can't make dividend
distributions unless they have accumulated Earnings and
Profits from when they were a C corporation prior to their
conversion to an S corporation. So, if a corporation has
always been an S corp, it will never have accumulated E&P
and can, therefore, never, ever pay a dividend.

Remember, distributions are not deductible and deductions
are not distributions. You can pick one or the other, but
it can't be both.

S corporation distributes $24K to stockholder. This reduces
basis, but basis can never be less than ZERO. What happens
here is that basis is reduced to ZERO and the excess $4,000
is a distribution in excess of basis and gets treated as a
capital gain - remember, a capital gain is when you get back
more from an investment than you put it.

As far as accumulating losses with an S corporation - basis
is the responsibility of the stockholder, not the
corporation. Basis needs to be tracked by the stockholder
not the corporation. When a stockholder's basis reaches
ZERO additional losses get suspended and carried forward and
can be used to offset income from the same S corporation in
future years. Let's change your numbers just a bit:

S corp has $40 income in year one - stockholder includes $40
as income on personal return, pays tax on $40, and has basis
of $40K S corp has $60 loss in year two - stockholder gets
to deduct $40 as loss on personal return, has basis of ZERO,
and has suspended carryforward loss of $20

S corp has $30 income in year three - stockholder includes
$30 as income AND deducts prior suspended loss of $20,
netting $10 income on personal return, pays tax on $10, and
now has basis of $10.

Hope this helps. But don't feel bad if it doesn't. Basis
is a tricky thing to calculate. Beyond the very basic
basics I've outlined here, there are specific ordering rules
that dictate which items get deducted from basis in which
order. AND, there are elections that can be made to change
the order in which the items are applied. Basis is tricky
to calculate and can be worse to understand. I've also
found that many accountants don't fully understand it.

Good luck,
Gene E. Utterback, EA
 
D

D.F.

As far as accumulating losses with an S corporation - basis
is the responsibility of the stockholder, not the
corporation. Basis needs to be tracked by the stockholder
not the corporation. When a stockholder's basis reaches
ZERO additional losses get suspended and carried forward and
can be used to offset income from the same S corporation in
future years. Let's change your numbers just a bit:

S corp has $40 income in year one - stockholder includes $40
as income on personal return, pays tax on $40, and has basis
of $40K S corp has $60 loss in year two - stockholder gets
to deduct $40 as loss on personal return, has basis of ZERO,
and has suspended carryforward loss of $20

S corp has $30 income in year three - stockholder includes
$30 as income AND deducts prior suspended loss of $20,
netting $10 income on personal return, pays tax on $10, and
now has basis of $10.
Suppose a person buys stock in an S corporation that he is
not associated with, other than owning 1% of the shares as a
passive investment. Does that same logic hold-- that
distributions are a return of capital until basis is zero?
Or does the passive nature change the rules?

I am not in that situation, but I am still curious. Thanks.
I am not in the owner situation either, but I liked reading
your explanation.
 
P

Phoebe Roberts, EA

D.F. said:
Suppose a person buys stock in an S corporation that he is
not associated with, other than owning 1% of the shares as a
passive investment. Does that same logic hold-- that
distributions are a return of capital until basis is zero?
S-corp distributions always reduce basis, but not below
zero. Active or passive makes no difference. S-corp losses
(whether allowable under the passive activity loss rules or
not) also reduce basis, but not below zero. You could
conceivably have PAL carryforwards, suspended losses due to
the at-risk rules, suspended losses due to lack of basis,
and (taxable) distributions in excess of basis if you were
unlucky enough.

Phoebe :)
 
Ad

Advertisements

D

David Woods, EA

D.F. said:
Gene E. Utterback, EA wrote:
Suppose a person buys stock in an S corporation that he is
not associated with, other than owning 1% of the shares as a
passive investment. Does that same logic hold-- that
distributions are a return of capital until basis is zero?
Or does the passive nature change the rules?

I am not in that situation, but I am still curious. Thanks.
I am not in the owner situation either, but I liked reading
your explanation.
Type of ownership is irrelevant to the tax treatment of
basis in an s-corp. Passive or active has no bearing on the
treatment of distributions.

--
David M. Woods, EA
Boston, MA 02109

Postings here are general information only and not to be
relied upon as advice.
 
G

Gene E. Utterback, EA

Type of ownership is irrelevant to the tax treatment of
basis in an s-corp. Passive or active has no bearing on the
treatment of distributions.
True, however passive ownership can create other problems
will allowing deductibility of ordinary losses, which can
only be offset against passive income.

Whenever I get into discussions about passive activities I
try to remember the catch phrase - if you have PALs (passive
activity losses) then you better also have PIGs (passive
income generators).

Gene E. Utterback, EA
 
H

Hamlet the Prince

Gene E. Utterback said:
. Basis is relatively straight forward, if you can stay focused.
.
. Basis is tricky to calculate and can be worse to understand.
I couldn't resist. Is basis straightforward or is it tricky?
 
Ad

Advertisements

G

Gene E. Utterback, EA

I couldn't resist. Is basis straightforward or is it tricky?
It is straightforward, in a tricky kind of way! (that's what
you get for not resisting!!!<wink>!!!)

Gene E. Utterback, EA
 

Ask a Question

Want to reply to this thread or ask your own question?

You'll need to choose a username for the site, which only take a couple of moments. After that, you can post your question and our members will help you out.

Ask a Question

Top