USA Effect on basis of excess distributions

[Drmdcpa]

I understand if either a partnership or S corp distributes in excess of basis, the owner/partner has a capital gain. Does this recognition of gain increase basis?

 

[Warren Scaman]

it is always the shareholder's responsibility to know his basis, and he should always require from his outside accountant a complete, detailed computation of his basis as part of any annual tax planning. It is never the responsibility of the S corporation to fulfill this personal responsibility: the corporation may not have all of the data necessary to compute the basis, which is the primary reason that it is not included on the face of the K-1 schedule; and the basis in the stock pertains to the personal tax returns of the shareholder, from whom the Internal Revenue Service will require substantiation of basis.

How is basis calculated for stock in a S corporation? First of all, there is an ordering rule in computing stock basis. Assuming for simplicity sake that the basis calculation pertains to a small closely held S corporation, where there were no dividend distributions reported on Form 1099-DIV nor distributions in excess of basis and no depletion deductions, stock basis would be adjusted annually, as of the last day of the S corporation year, in the following order:

1. Increased by all income (including tax-exempt income) reported on Schedule K-1;
2. Increased by any capital contributions, including stock purchases;
3. Decreased by cash and property distributions made by the corporation reported on Schedule K-1, box 16, code D;
4. Decreased by nondeductible expenses;
5. Decreased by all deductible losses and deductions reported on Schedule K-1 adjusted for any charitable contributions of property, by subtracting the excess of the property's fair market value over its adjusted basis.

When determining the taxability of a non-dividend distribution the shareholder looks solely to his stock basis. For losses and deductions which exceed a shareholder’s stock basis, the shareholder is allowed to deduct the excess up to the shareholder’s basis in loans personally made to the S corporation (see item 4 below). Debt basis would be adjusted annually similarly to stock basis but there are some differences:

1. Beginning of year loan basis;
2. Increased by loans made to company, including interest capitalized (i.e., not paid);
3. Decreased by payments on loan;
4. Decreased by any losses or deductions in excess of shareholder's stock basis.

Basis can never be reduced below zero. Losses are carried forward to future years. If there exists no debt, then the basis of the stock at the beginning of the year is zero, which is then adjusted by any losses or deductions from prior years.