How do I calculate basis in S Corporation stock and debt?
Basis records must be correctly maintained because basis (1) limits the amount of corporate loss that can be deducted by shareholders, (2) determines gain or loss when stock is disposed of, and (3) determines the amount of tax-free distributions that can be received from the S corporation. Keeping track of basis is the shareholder’s (not the corporation’s) responsibility. This differs from the Retained Earnings Account, and the Accumulated Adjustments Account. Most practitioners engaged to prepare Form 1120S will determine the individual S shareholders’ stock and debt bases annually and advise the shareholders of their bases at the time Form 1120S is completed.
In at nutshell, stock basis is determined by adding to the initial cost of the shares:
(a) additional stock purchases and capital contributions
(b) separately stated income items
(c) nonseparately stated income items
Then decreasing this figure by:
(a) shareholder draw
(b) separately stated losses and deduction
(c) nonseparately stated losses
(d) nondeductible corporate expenses
(e) Sale or other disposition of stock
An S corporation shareholder receives basis for debt that it is owed directly to the shareholder by the corporation. A shareholder’s guarantee of a loan made to the corporation by a third party does not provide basis. Another possibility is for the shareholder to borrow money from the bank, loan it to S Corp, and have S Corp pay off its original note to the bank. The IRS has ruled that this transaction gives the shareholder debt basis if:
(1) the shareholder is personally liable for the bank loan to the shareholder,
(2) the corporation is not a guarantor or co-maker on the bank loan to the shareholder, and
(3) the interest rate on the bank’s loan to the shareholder is the bank’s current rate.
If all conditions are met, the shareholder will receive debt basis, even if bank loan is secured by his stock in the S Corp.
Debt basis is reduced by:
(1) principle payments on the debt
(2) deduction of corporation losses against the debt
and increased by:
(1) net income allocated to debt restoration
Repayment of these loans is a taxable event to the shareholder to the extent a full repayment exceeds the shareholder’s basis in the debt, or to the extent partial repayments exceed a prorated portion of the debt basis.
Stock and debt basis cannot be reduced below zero. The use of a Stock and Debt Worksheet, such as the one provided in the Small Business Quickfinder Handbook can greatly aid the process of calculating basis.
RETURN TO QUESTIONS