S corporation Tax Basis

Two components make up your tax basis:

• Stock basis
• Loan basis (if any)

Stock Basis

The total amount of money and property you contribute to an S corporation in exchange for its stock equals your initial stock basis. At the end of each year you must increase or decrease your stock basis to account for your share of certain items (covered next).

Adjusting Your Stock Basis

You must adjust your stock basis at the end of each tax year. After making the adjustments, the final result is your adjusted stock basis. Stock basis is important. It is used to determine the amount of a loss you may deduct on your individual income tax return, the amount of a distribution you may take before incurring a taxable capital gain, and your gain or loss if you sell your stock.

Items that Increase or Decrease Your Stock Basis

Certain items either increase or decrease stock basis. The following items increase stock basis:

• Increase Your Stock Basis By:
  • Non-separately stated income:
    • This is S corporation gross income minus expenses (represents ordinary business income). This computation excludes separately stated items.
  • Items of income separately treated:
    • These are items of income that are computed separately from the corporation's ordinary net income.
      • For example, net short-term capital gain, net long-term capital gain.
      • Separately stated items are listed on separate lines on Schedule K-1, below the line that includes the corporation's ordinary business income (or loss).
  • Tax exempt income
  • Deduction for excess depletion
• Decrease Your Stock Basis By:
  • Non-separately stated loss:
    • This is S corporation gross income minus expenses (represents ordinary business loss). This computation excludes separately stated items.
  • Separately stated loss and deduction items (e.g., charitable contributions, Section 179 deduction, capital losses)
  • Nontaxable distributions:
    • Whether S corp. net income is distributed to you or not, you still report the income on your personal income tax return in the year earned. If the net income is subsequently distributed to you, it is tax free up to the amount of your stock basis. The distribution is tax free because it has already been included in your personal income tax return where it was subject to income taxes. This is why it is called a nontaxable distribution.
    • For example, as of December 31, 2016 your S corp. had a $10,000 net profit. Your 2016 stock basis is increased by the $10,000 net profit. In addition, you include the $10,000 in your 2016 personal income tax return. During January 2017 the $10,000 is distributed to you. Your stock basis is reduced by $10,000 distribution and the distribution is tax free because you already included it in your 2016 personal income tax return.
  • Nondeductible expenses:
    • For example, the nondeductible portion of meals and entertainment.
    • Nondeductible fines and penalties.
    • Your share of depletion for oil and gas properties held by the S corporation not in excess of the property's basis.
  • Excess distributions:
    • Distributions that exceed the adjusted basis of your stock are treated as a gain from the sale or exchange of property. For example, if your stock basis is $10,000 and your distribution is $12,000, $2,000 is a taxable gain. The gain is a capital gain, (short-term if stock owned one year or less, long-term if stock held more than one year).

Three Reasons Why Annual Stock Basis Adjustments Are Made

• Gain or loss determination:
  • To compute your gain or loss if you dispose of your stock you need to know your adjusted stock basis.
• To ensure that correct distributions are made:
  • To comply with S corporation distribution rules, each shareholder must receive distributions in accordance with his percentage of ownership.
• Avoid reclassification to C status: S corporations may only have one class of stock.
  • If disproportionate distributions are made to any shareholders it could imply the existence of a second class of stock.
    • For example, if a shareholder gets 50% of the profits but only owns 25% of the stock, this is a disproportionate distribution.
  • The IRS could reclassify the S corporation to a C corporation if it concludes disproportionate distributions were made.
  • If reclassified, the S corporation would be subjected to C corporation tax treatment.