Taxing Definitions

Definition — Puzzling out the basis

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Love is the basis for everything except S corporation stock. For that, income, losses, deductions, and credits are what count.

The IRS discusses the calculation of basis for S corporation shareholders in the international practice unit guidance released on April 30 titled Losses Claimed in Excess of Basis.

As you know, shareholders can only claim S corporation losses and deductions up to their adjusted basis in stock and debt. Basis can’t be reduced below zero and any losses or deductions disallowed due to the limitation are carried forward indefinitely and used in years with sufficient basis.

Here are examples to test your skill in calculating whether a shareholder has sufficient basis to claim losses and deductions passed through from an S corporation.

Example 1

The sole owner of an S corporation received a Schedule K-1 reporting the following income and deduction items for the corporation’s initial year of business:

Ordinary Income $5,000

Section 1231 Loss ($8,000)

Charitable Contributions $1,000

 

WHAT IS THE SHAREHOLDER’S STOCK BASIS AT THE END OF THE YEAR?

or

 

Example 2

The sole owner of an S corporation has stock basis of $9,000 at the beginning of the year. At year-end, the shareholder receives Schedule K-1 with the following information:

Ordinary Loss ($20,000)

Section 1231 Gain $4,000

Cash Charitable Contributions $5,000

Non-Deductible Travel & Entertainment $1,000

TIP: The order in which stock basis is increased or decreased is important. Because both the taxability of a distribution and the deductibility of a loss are dependent on stock basis, there is an ordering rule in computing stock basis. Stock basis is adjusted annually, as of the last day of the S corporation year, in the following order:

1) Increased for income items and excess depletion;

2) Decreased for distributions;

3) Decreased for non-deductible, non-capital expenses and depletion; and

4) Decreased for items of loss and deduction.

 

WHAT IS THE SHAREHOLDER’S STOCK BASIS AT THE END OF THE YEAR?

or

 

Example 3

The sole shareholder of an S corporation has stock basis of zero at the beginning of the year, and a suspended carryover of $13,000, consisting of an ordinary loss of $10,400 and charitable contributions of $2,600. At year-end, the shareholder receives a Schedule K-1 with the following information:

Ordinary Income $35,000

Section 1231 Loss ($10,000)

Cash Charitable Contributions $1,000

Non-Deductible Travel & Entertainment $5,000

 

WHAT IS THE SHAREHOLDER’S STOCK BASIS AT THE END OF THE YEAR?

or

 

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Note: Taxing Lessons provides a summarized version of sometimes lengthy IRS documents. The full document may include facts and issues not presented here. Please use the link provided in the post to read the entire document.

This information should not be considered legal, investment, or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment, or tax advice. Always consult your legal, investment, and/or tax advisor regarding your personal situation.

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Sorry, wrong answer :(
Right answer!

Basis can’t be less than zero. The shareholder has a stock basis of zero and a $4,000 suspended loss carryforward.

Calculation:

Beginning Basis $0

Ordinary Income $5,000

Section 1231 Loss ($8,000)

Charitable Contributions ($1,000)

Suspended Carryforward ($4,000)

Sorry, wrong answer :(
Right answer!

Since the items that reduce basis exceed the shareholder’s stock basis, the loss is limited to the amount of stock basis.

First, the stock basis ordering rules are applied to arrive at stock basis before losses and deductions. Since there is more than one type of loss and deduction item which reduces basis, the amounts allowed as a loss or deduction must be prorated as follows:

Beginning Stock Basis $9,000

Section 1231 Gain $4,000

Stock Basis Before Non-Deductible Exp. $13,000

Non-Deductible Travel & Entertainment ($1,000)

Stock Basis Before Losses & Deductions $12,000

Ordinary Loss ($9,600)—Proration: ((20,000 / (20,000 + 5,000)) x 12,000

Cash Charitable Contribution ($2,400)—Proration: ((5,000 / (20,000 + 5,000)) x 12,000

Ending Stock Basis $0

The carryover to the next taxable year is:

Ordinary Loss ($10,400)—Calculation: (20,000) – (9,600)

Cash Charitable Contribution ($2,600)—Calculation: (5,000) – (2,400)

Total Carryover ($13,000)—Calculation: (25,000) – (12,000)

Sorry, wrong answer :(
Right answer!

Calculation:

Beginning Stock Basis $0

Ordinary Income $35,000

Stock Basis Before Non-Deductible Exp. $35,000

Non-Deductible Travel & Entertainment ($5,000)

Stock Basis Before Losses & Deductions $30,000

Ordinary Loss ($10,400)—Calculation: (0 + (10,400))

Section 1231 Loss ($10,000)

Cash Charitable Contributions ($3,600)—Calculation: ((1,000) + (2,600))

Ending Stock Basis $6,000

Although the Schedule K-1 only shows the current year income items, the shareholder is allowed to take the previously suspended losses. Suspended losses may not be combined with current income amounts, but must be listed on a separate line on the Form 1040, Schedule E, Supplemental Income and Loss, or the appropriate schedule when possible. Suspended ordinary loss carryover is not netted with the current year ordinary income when applying the stock basis ordering rules.

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