With an S Corporation,
there are three shareholder loss limitation rules. Each limitation must be met,
in the following order, before a shareholder is allowed to claim a flow-through
loss deduction.
1. Stock and Debt Basis
Limitations
2. At Risk Limitations
3. Passive Activity Loss
Limitations
S Corporation Shareholders
are Required to Compute Both Stock and Debt Basis EACH year, which increases or
decreases based upon the S corporation's operations.
This is important for the
following reasons:
In order for a shareholder
to claim a flow through loss or deduction item, they need to have
adequate stock and or debt basis.
In order for a shareholder
to determine whether or not a non-dividend distribution is non-taxable,
they need to demonstrate they have adequate stock basis. When a shareholder
receives a non-dividend distribution, the distribution is tax-free to the
extent it does not exceed the shareholder's stock basis. debt basis is not
considered when determining the taxability of a distribution).
As with any asset, when the
stock is sold or disposed of, basis needs to be established in order to
determine the proper gain or loss on the sale or disposition.
When computing stock basis,
the shareholder starts with their initial capital contribution to the S
Corporation or the initial cost of the stock they purchased.
A shareholder's stock basis
is increased for the following items:
Ordinary business income
Separately stated income
items
Tax exempt income
A shareholder's stock basis
is decreased for the following items:
Ordinary business loss
Separately stated loss
items
Non-deductible non-capital
expenses
Non-dividend distributions
There is an ORDERING RULE
that must be followed in computing stock basis as follows:
Stock Basis is adjusted
annually, as of the last day of the S corporation year, in the following order:
1st-Increased for all
income items
2nd-Decreased for
non-dividend distributions
3rd-Decreased for
non-deductible non-capital expenses
4th-Decreased for loss and
deduction items.
As stated earlier, when
determining the taxability of a non-dividend distribution, the shareholder
looks solely to his/her stock basis (debt basis in not considered).
For loss and deduction
items, which exceed a shareholder's stock basis, the shareholder is allowed to
deduct the excess up to the shareholder's debt basis (which are shareholder
loans personally made the the S corporation).
If a shareholder has S
corporation loss and deduction items in excess of stock basis and those losses
and deductions are claimed based on debt basis, the debt basis of the
shareholder will be reduced by the claimed losses and deductions.
It is important to note
that if an S corporation repays reduced debt basis to the shareholder, part or
all of the repayment is taxable to the shareholder.
Also, for a shareholder to
have debt basis, the shareholder must personally make a (real) loan of money to
the corporation. A loan guarantee is not sufficient to create debt basis.
The loss and deduction
items in excess of stock and debt basis:
Retain their character
Are treated as loss and
deduction items in the subsequent tax year and will be allowed if the
shareholder has increased and or restored stock and or debt basis
Carryover indefinitely or
until all of the shareholder's stock is disposed of
Tracking stock and debt
basis each year will help the shareholder plan for potential distributions and
losses and deductions and ensure there are no unexpected and no unintended
surprises at tax time.
This article was written by Donald M. Scherzi, CPA, CFP, LLC
Mike Lupo,
SCORE Counselor
Visit us at: www.scoresouthflorida.net
