S Corporation Stock and Debt Basis

Shareholder Loss Limitations

• S Corporation: A corporation with a valid "S" election allowing income/losses to flow to the shareholder's personal tax return.
• Reasons for S Corporation Status:
  1. Avoid double taxation on distributions.
  2. Allow corporate losses to pass through to owners.
• Loss Limitations:
  1. Stock and debt basis limitations
  2. At-risk limitations
  3. Passive activity loss limitations
  4. Excess business loss limitation
• Shareholders must meet these limitations to claim pass-through losses.

Stock and Debt Basis

• Importance: The stock and debt basis affects how income, losses, and distributions are taxed.
• Stock and Debt Basis Computation: Shareholder responsibility to compute annually as it fluctuates with corporate operations.
• Non-Dividend Distributions: Tax-free up to stock basis; debt basis is not considered.

Loss or Deduction Pass-Through Items

• Shareholders must have adequate stock/debt basis to claim losses/deductions.
• Consider at-risk and passive activity loss limitations even if basis is sufficient.

Importance of Stock Basis

• When it Matters:
  • Loss/deduction allocations
  • Non-dividend distributions
  • Stock disposition
• Annual Computation Required: Use Form 7203 to calculate stock and debt basis.

Computing Stock Basis

• Initial Basis: Starts with capital contribution or purchase cost.
• Adjustments:
  • Increase with income items.
  • Decrease with losses, deductions, or distributions.
• Order of Adjustment:
  1. Increase for income
  2. Decrease for distributions
  3. Decrease for non-deductible expenses
  4. Decrease for loss/deduction items

Example: Stock Basis Calculation

• Example: Mark, the sole shareholder, adjusts his stock basis based on income, distributions, and expenses.
• Stock Basis Adjustments:
  • Increased by income
  • Reduced by non-dividend distributions
  • Reduced by non-deductible expenses
  • Reduced by loss/deduction items

Important Considerations

• Non-Dividend versus Dividend Distributions: Only non-dividend distributions reduce stock basis.
• Capital Gains: Excess non-dividend distributions taxed as capital gains.
• Suspended Losses and Deductions:
  • Carryover indefinitely unless all stock is disposed.
  • Retain character for future deductions.

Other Key Points

• Debt Basis: Only granted for personal loans to the corporation.
• Loan Guarantees: Do not establish debt basis.
• Repayment and Sale of Stock:
  • Repayment of reduced basis debt can be taxable.
  • Suspended losses are lost if all stock is sold.

These notes summarize key elements of S corporation stock and debt basis, shareholder responsibilities, and tax computations.