S corporation Tax Basis

Two components make up your tax basis:

  • Stock basis
  • Loan basis (if any)

Your 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.

Then, at the end of each year you must increase or decrease your stock basis to account for your share of certain items (covered next).

The result of these increases and decreases is your adjusted stock basis.

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 the adjusted stock basis.

You must know your stock basis in order to determine gain or loss should you sell your stock.

Items that Increase or Decrease Your Stock Basis

    • 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
    • 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
      • NOTE: Undistributed income is taxed to you and increases your stock basis (yes, you can pay taxes on income you never actually received).
      • Distributed income that has already been taxed is not taxed again (that's why it's called a nontaxable distribution) and it decreases your stock basis.
    • 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.

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.

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