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S-Corporation
Shareholder Basis
By: Renee
Daggett
General
Definition:
If you have ownership in an S-corporation it is important to have a general
understanding of basis. This number called “basis” increases and
decreases with the activity of the company. The IRS defines it as the
amount of one’s investment in the business for tax purposes. When the
S-corporation files a tax return (1120S), all shareholders receive a K-1 form
to show profits, losses and deductions allocated to the shareholder.
The K-1 does not state the taxable amount of the distribution, which is
contingent on the stock basis. The main purpose of basis is to
determine if distributions are taxable or losses are deductible. The
basis for each shareholder is calculated annually and must be tracked from
day 1 of ownership.
 Importance of Basis:
It is important to calculate the basis for the following reasons:
•If the shareholder receives a distribution and has basis to cover the
amount, the withdrawal is not taxable to the shareholder.
•If the shareholder has a loss in the company and has basis to cover the
amount, the losses will be allowed to be taken in that tax year.
•When the shareholder disposes of his/her stock, gain or loss on the
disposition is calculated using the shareholder’s stock basis.
How
Basis is Calculated:
Think of basis like a checking account. The account goes up and down,
but can never go negative. When there is a deposit of income, the
basis goes up for all shareholders based upon percentage of
ownership. When there is a payment of an expense, the basis goes
down. When a shareholder contributes money to the company, the basis
goes up. When a shareholder withdraws money, the basis goes
down. Basis is also decreased by several activities like penalties
the company had to pay, section 179 deductions on assets or the
non-deductible portion of meals and entertainment. (So be aware that
all the meals you eat out on the company’s dime actually “eat up” half of
your basis!)
In year 1, you start out with a zero
basis. For the activity of the first year in business, you then have
an ending basis. This ending basis in year 1 is your beginning basis
number for year 2. This continues as long as a personal has ownership
in a company.
There is an ordering rule of how the basis is
calculated (what numbers are adjusted first, next and last), but I won’t go
into further explaining since it is more complicated.
Please see the last page of this article for a
sample of a Shareholder’s Basis Worksheet.
Suspended
Losses:
Normally a shareholder that has basis in the company can reduce their other
income (W-2 wages, interest, dividends, rental, etc.) on their personal tax
return with the losses of the company. This is a really nice
advantage of the S-corporation! However, if the shareholder does not
have basis to go against that loss, the loss is suspended and disallowed
for that tax year to offset other income. The losses are carried over
indefinitely until the shareholder has more basis.
Distributions:
In general, if a shareholder withdraws money from the company outside of
payroll, the distribution will only reduce the basis in the company.
This is another benefit of an S-corporation! Regular corporations
(C-corps) tax the shareholder for pulling out money, called
dividends. You’ve probably heard the phrase, “double taxation on
C-corps”. In an S-corp, that does not happen if you have basis.
So what happens if you don’t have basis and you pull money out? The
amount that exceeds the basis will be taxed as a capital gain on the
shareholder’s personal return. Here is an example:
Beginning Stock Basis = $25,000
Current year Loss =
$-20,000
-----------
Ending Stock Basis = $5,000
Distributions
=
$10,000
-----------
Distribution Above Basis $5,000 (This is the amount
the shareholder will be taxed at the capital gains rate!)
So now do you see why tracking basis is
important?
Reconstructing
Basis:
When you change tax preparers, a good sign that they are competent is if
they ask for your basis schedules the first year they prepare your
return. If they do not have the schedule, they will need to recreate
it from year 1. Reconstructing the basis is not very difficult as
long as all the K-1’s and records are available for every year in
business.
Even if a company has been tracking basis, it
does not necessarily mean that the numbers are correct. Remember
garbage in, garbage out holds true for basis schedules.
Two
Types of Basis:
There are two types of basis numbers that need to be tracked: stock basis
and debt basis. Most of what you read above is stock basis.
However, debt basis is a tad more complicated. For a shareholder to
receive debt basis, the shareholder must make a direct loan to the
corporation. The shareholder bears some risk in loaning the company
money. Always have a promissory note and collect interest on the
loan. Repayments of the loan are calculated against the debt
basis. If the shareholders stock basis is zero, then losses are still
allowed if there is debt basis. If the debt is repaid before the
stock basis is restored, then all or part of the repayment of the loan may
be taxable.
The
End in Mind:
Every shareholder should be thinking of the end of the year. What is
done before December 31 is tax planning and every owner should be
strategizing so there are no surprises come tax time.
Did You Know?
 •I have had someone tell me that they want to
deduct their auto 100% because they
have a business sign on the vehicle. They said they see
this as advertising. Sorry…the IRS’ rules don’t agree. You can deduct the
cost of the signs, but the auto rules are the same – it is based on
the percentage of business miles.
•You cannot deduct miles driven from your home to your first
location unless you qualify and claim the home office
deduction.
•2013
is a little over half way done so make sure your books
are reconciled up to date, write down your odometer reading
and backup your computer.
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