S Corp. Stock – Debt
S Corp. Stock – Debt Basis – generally, the deduction for your share of aggregate losses and deductions reported on Schedule K-1 is limited to the basis of your stock and loans from you to the corporation. We are getting the sense that IRS is going to substantially increase its focus on the reporting of gains from distributions in excess of tax basis for an S Corporation shareholders stock and debt. We are currently building tracking templates that will extract information for QBOnline and let us populate the worksheets for our clients…supplemental worksheets in the works for allocation of types of loss allowed, passive losses under IRC Sec. 469, at-risk calculations under IRC. Sec. 465, and IRC Sec. 199A calculations.
We thought we would begin with a detailed review of the rules for calculating S Corporation stock and debt because it is a topic that most practitioners don’t know as well as they should.
S Corp. Stock – Debt
For details and exceptions, see IRC 1366(d). The basis of your stock is generally figured at the end of the corporation’s tax year. Any losses and deductions not allowed this year because of the basis limit can be carried forward indefinitely and deducted in a later year subject to the basis limit for that year.
You are responsible for keeping the information needed to figure the basis of your stock in the corporation. Schedule K-1 provides information to help you figure your stock basis at the end of each corporate tax year. The basis of your stock (generally, its cost) is adjusted annually as follows and, except as noted, in the order listed. In addition, basis may be adjusted under other provisions of the Internal Revenue Code,
The basis is increased by (a) all income (including tax-exempt income) reported on Schedule K-1 and (b) the excess of the deduction for depletion (other than oil and gas depletion) over the basis of the property subject to depletion,You must report on your return (if you are required to file one) any amount required to be included in gross income for it to increase your basis.
Basis is decreased (but not below zero) by (a) property distributions (including cash) made by the corporation reported on Schedule K-1, box 16, code D, minus (b) the amount of such distributions in excess of the basis in your stock.
Basis is decreased (but not below zero) by (a) nondeductible expenses and (b) the depletion deduction for any oil and gas property held by the corporation, but only to the extent your share of the property’s adjusted basis exceeds that deduction.
Basis is by all losses and deductions reported on Schedule K-1.
You may elect to decrease your basis under prior to decreasing your basis under. If you make this election, any amount described under that exceeds the basis of your stock and debt owed to you by the corporation is treated as an amount described under for the following tax year.
To make the election, attach a statement to your timely filed original or amended return that states you agree to the carryover rule of Reg. Sec. 1.1367-1(g) and the name of the S corporation to which the rule applies. Once made, the election applies to the year for which it is made and all future tax years for that S corporation unless the IRS agrees to revoke your election.
The basis of each share of stock is increased or decreased (but not below zero) based on its pro rata share of the above adjustments. If the total decreases in basis attributable to a share exceed that share’s basis, the excess reduces (but not below zero) the remaining bases of all other shares of stock in proportion to the remaining basis of each of those shares.
Basis isn’t increased by an excluded discharge of indebtedness income of the S corporation under IRC Secs. 108(a) and 108(d)(7)(A)
If a portion of your stock is redeemed, sold, or otherwise disposed of during the year, attach two separate worksheets. Use the first to figure your stock basis at the date of sale and the second to figure your stock and debt basis at year end.
The basis of your loans to the corporation is generally the balance the corporation owes you, adjusted for any reductions and restorations of loan basis (see the instructions for box 16, code E). Any amounts described in (3) and (4), earlier, not used to offset amounts in (1), earlier, or reduce your stock basis, are used to reduce your loan basis (to the extent of such basis prior to such reduction).
When determining your basis in loans to the corporation, remember that:
Distributions don’t reduce loan basis, and
Loans that a shareholder guarantees or co-signs aren’t part of a shareholder’s loan basis. Shareholders only obtain basis from acting as a guarantee or in a similar capacity to the extent the shareholder makes a payment pursuant to the guarantee. See Reg. Secs. 1.1366-2(a) and section 1367 and its regulations for more details.
S Corp. Stock – Debt
You must account for each formal note (notes with a written instrument) made to your S corporation by entering it separately in its own column. You can’t aggregate multiple loans into a single column. If you have more than 3 loans, use additional copies of Part II.
Loans made to the S corporation that isn’t evidenced by a written instrument are referred to as an open account debt and aren’t separately tracked. If an open account debt has a year-end balance of more than $25,000, it will be classified as af ormal note at the beginning of the next tax year and must be separately tracked.
Loans that a shareholder guarantees or co-signs aren’t part of a shareholder’s loan basis except to the extent the shareholder makes a payment on the loan guaranteed or co-signed.
Any debt that exceeded $25,000 at the end of the prior year is treated as a formal note for purposes of calculating the gain on loan repayment. See Reg. Sec. 1.1367-2(a)(2)(ii).
If you have multiple debts, the net increase is applied first to restore the reduction of basis in any debt repaid in the tax year to the extent necessary to offset any gain that would otherwise be realized. Any remaining net increase is applied to each debt in proportion to its reduced basis. See Reg. Sec.1.1367-2(c)(2).
If you have more than one loan to the corporation, any allocated reduction is prorated to the loans based on the ratio that each individual loan basis bears to the aggregate bases of the loans. See Reg. Sec. 1.1367-2(b)(3).
The character of the gain on repayment is dependent on whether the debt is evidenced by a formal note or is an open account. Debt evidenced by a formal note will result in capital gain and should be reported on Form 8949 and Schedule D. Any open account debt will result in an ordinary gain and should be reported on Form 4797.
Gain recognized on loan repayment doesn’t increase basis.
We trust that this overview will be helpful…if you are interested in the QBO templates you can learn more here.
S Corp. Stock – Debt