If you are a shareholder of an S corporation you are responsible for keeping track of your own basis (investment value) in the S corporation of which you own shares. Tracking shareholder basis is usually not the S corporation’s responsibility.
You can have stock basis and loan basis, which are usually adjusted each year based on the S corporation’s operations.
It is important to annually calculate your shareholders basis in the S corporation stock you own for the following reasons:
• You can claim losses and deductions passed through on Schedule K-1 to the extent of their stock and loan basis [§1366(d)(1)].
• If you receive a non-dividend distribution from the S corporation, it’s nontaxable to the extent of you stock basis [§1368(b)(1)].
• When you disposes of the S corporation stock, gain or loss on the disposition is calculated using you stock basis.
Stock basis starts with your initial contribution of capital to the S corporation’s capital account or the price paid for the stock. This amount is adjusted annually, as of the last day of the S corporation year, in the following order [Reg. §1.1367-1(f)]:
(1) Increased by all income including tax-exempt income reported on Schedule K-1 and excess depletion.
(2) Decreased by property distributions including cash made by the S corporation that are reported on Schedule K-1 in Box 16 with code D.
(3) Decreased by nondeductible non capital expenses, such as illegal bribes, kickbacks, fines and penalties, expenses and interest related to tax-exempt income, and the nondeductible portion of meals and entertainment.
(4) Decreased by deductible losses and deductions reported on Schedule K-1.
Stock basis can never go below zero.
If non dividend distributions exceed stock basis, the excess is taxed as capital gain on your personal return [§1368(b)(2)].
If deductible losses and deductions exceed stock basis, they can be deducted to the extent you have loan basis and any amount in excess of loan basis is suspended and carried over to the succeeding tax year.
You can elect to reduce your stock basis by deductible losses and deductions before decreasing their basis by non deductible expenses [Reg. §1.1367-1(g)]. If this election is made and nondeductible expenses exceed your stock and loan basis, the excess retains its character and is carried over to the succeeding tax year. If the election is not made, any excess nondeductible expenses are lost, not suspended and not carried over.
Loan basis starts with a loan substantiated with loan documentation from you the shareholder of the S corporation to the S corporation. In other words, it includes a traditional, written note with a reasonable stated rate of interest. It does not include third party loans to the S corporation that you guarantee or co-signs.
Loan basis is adjusted as follows: