Understanding S Corporation Basis: A Simple Guide

In an S corporation, owners can only deduct the company’s losses or expenses if their basis is high enough. Basis means how much money the shareholder has invested in the company, including both the stock they own and any loans they’ve made to the company. It’s really important for shareholders to keep track of their basis levels.

There are two types of basis:

1. Stock basis – This comes from the money or assets shareholders invest in the company.

2. Debt basis – This comes from any loans shareholders give to the company.

   
   

What Increases Your Stock Basis?

• Income: If the company makes money, the shareholder's basis increases.

• Special Income: Certain types of income, like capital gains or tax-free interest, also increase the basis.

• Additional Contributions: If the shareholder adds more money to the company, their basis goes up.

  
  

What Decreases Your Basis?

• Losses: If the company loses money, the shareholder’s basis goes down.

• Special Losses: Some losses, like capital losses or tax-exempt expenses, decrease the basis.

• Non-Deductible Expenses: Things like fines or penalties that can’t be deducted from taxable income will lower the basis.

• Distributions: If the company gives money or property to shareholders, it lowers their basis.

  
  

A Simple Example of Stock Basis

Let’s say Alex starts a company and buys all the shares for $250,000. The company makes a profit of $400,000 in the first year, and Alex pays taxes on that profit. Alex doesn’t put more money into the company, and she doesn’t take anything out.

So, how much is her basis now?

• Original investment: $250,000

• Profit: $400,000

  
  

Total basis = $250,000 + $400,000 = $650,000.

After that, Alex decides to sell the company for $750,000.

So, how much does Alex make?$750,000 (sale price) - $650,000 (basis) = $150,000 profit.

Why is it only $150,000? Because Alex already paid taxes on the $400,000 profit, so that’s already included in her basis.

Important S-Corp Basis Rules

1. No Negative Basis: A shareholder can never have a negative basis. That means you can’t owe more than what you’ve invested in the company.

2. Excess Distributions: If a shareholder gets more money from the company than their stock basis (more than they’ve invested), the extra amount is treated as a profit and taxed as a capital gain.

3. Carrying Forward Losses: If a shareholder doesn’t have enough basis to cover a loss, they can carry that loss forward to future years. However, only that specific shareholder can use the loss, and it can’t be transferred to someone else.

   
   

Debt Basis in S Corporations

Sometimes, a shareholder might lend money to the company. This is where loan basis comes in. If the shareholder’s stock basis runs out, they can still use their loan basis to cover losses from the company.

However, there are rules to make sure that loans don’t turn into another type of stock an ruin S Corp stock. For the loan to count, it needs to:

• Be in writing with clear repayment terms.

• Have an unconditional promise to repay by a certain date.

• Include interest payments that are not optional.

• Not convert into company stock.

• Be given by an eligible lender (not certain trusts or non-residents).

  
  

A Debt Basis Example

Let’s say Alex and Mike each own 50% of a company and each contributed $1,000. In their first year, the company struggles and loses $150,000. Mike can’t lend more money because of personal expenses, but Alex lends the company $120,000.

The company’s loss is split equally:

• $75,000 of the loss goes to each shareholder.

  
  

Now, Alex has a loan basis of $120,000, but she can only use $75,000 of that to cover her share of the loss. The rest of her loan basis can be used in the future. Mike can only use his $1,000 basis to cover his loss, and the remaining $74,000 of his loss can be carried forward.

Restoring Debt Basis

If the company makes a profit in the future, the shareholder’s loan basis can be restored (or increased) based on their share of those future profits. Once the loan basis is restored, the rest gets applies to stock basis and the shareholder can use it again to cover future losses.

Conclusion

Tracking your stock and loan basis is important for S Corp owners. Stock affects how owners handle their business losses, distributions, and taxes. If you are still confused about S Corp Basis and have questions, please reach out! We helped numerous S Corp owners with their tax and accounting problems. You can check our services here