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Calculation
of Shareholder's Stock and Debt Basis in S Corporation
It is your responsibility to know your basis in an S corporation. Do you know how to calculate it? It is important for the shareholder of an S corporation to know his basis in the shares of stock that he owns as well as loans made to the company. What is basis? The Internal Revenue Service defines basis generally as the amount of one's investment in a property for tax purposes. It is used to figure depreciation, amortization, depletion, casualty losses, and any gain or loss on the sale, exchange or other disposition of the property. Unlike a C corporation, each year the stock and debt basis of an S corporation may change based upon the S corporation’s operations and financing arrangements. Every year the S corporation is required to issue a shareholder a Schedule K-1. The K-1 reflects the S corporation’s income, loss and deductions allocated to the shareholder for the year. The K-1 does not state the taxable amount of the distribution. The taxable amount of distribution is contingent on the shareholder’s stock basis. It is not the corporation’s responsibility to track a shareholder’s stock and debt basis; rather it is the shareholder’s responsibility. The certified public accountants of the shareholder need to calculate basis each year in order to prepare their personal tax returns. Why is this important? If a shareholder is allocated an S corporation loss or deduction flow-through, the shareholder must first have adequate stock and debt basis to claim that loss or deduction. It is recommended that shareholders, particulary those of closely held S corporations, receive some sort of tax planning before year end, including a review of their current basis in any S corporation stock. Failure to do so can have costly consequences. For instance, I personally know of a situation where the outside CPA met with the shareholders of a closely held S corporation before year end as part of his tax planning services and he failed to inform them of their current basis. Subsequent to the tax planning consultation, the shareholders made major purchases of equipment to maximize their section 179 deduction so that they could reduce their tax liabilities on their tax returns, only to discover the following March that $30,000 in tax deductions were unavailable because of the lack of sufficient basis in their stock. If the tax accountant simply had informed them of their basis available at the beginning of the year, the shareholders could have transferred basis from their other companies to increase their basis enough in the S corporation in order to deduct all of its section 179 expenditures and defer $30,000 in taxes. Nevertheless, 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:
In order to illustrate the calculation of basis, assume a shareholder's basis at the beginning of the year is $10,000, and his K-1 shows the following values for the tax year:
To calculate the basis in the shareholder's stock in the S corporation as of the end of the tax year, the following computation would be undertaken:
Note that because basis can never be zero, the $14,000 in excess deductions would either be carried forward to future years if there were no debt basis in the company. If we assume the shareholder's debt basis at the beginning of the year was $50,000, and that he had made $10,000 in principal payments on the debt during the year, we would be able to deduct the $14,000 in excess deductions against any existing debt basis as follows:
This example was deliberately kept simple to provide the very basics of the calculation of shareholder basis in the stock and debt of a closely-held S corporation. For more information on shareholder tax basis in S corporations, and other tax and accounting issues, please contact William Brighenti, Certified Public Accountant, Hartford CPA Accountants. If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. The above tax advice was written to support the promotion or marketing of the accounting practice of the publisher and any transaction described herein. The taxpayer recipients of this offering memorandum should seek tax advice based on their particular circumstances from an independent tax advisor |
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