S corporation Loan Basis

Direct loans you make to the S corporation from your own resources increase your loan basis. Loans others make that you merely guarantee don't count unless you pay the loan.

If you borrow funds to finance an activity or to acquire an ownership interest, you may or may not be considered at risk. (See Borrowed Funds Used in the Business, next.)

Borrowed Funds Used in the Business

You are considered at risk for funds you borrow that are used in the business if:

  • You are personally liable for repayment (recourse loans), or
  • The loan is secured by your property which is not used in the activity.
    • Exception:
      • Most real estate nonrecourse financing can qualify as at-risk if the financing is secured by real property used in the activity. (Check with your tax adviser for the rules.)

You are not considered at risk for the following funds borrowed by you and used in the business:

  • Nonrecourse loans that are not secured by your own property which is not used in the business.
    • See the exception above for nonrecourse financing involving real estate used in the activity.
  • Borrowed amounts that are protected against loss by a guarantee, stop-loss agreement, or other similar arrangement (excluding casualty insurance and insurance against tort liability).
  • Amounts borrowed from a person who has an interest in the business, other than a creditor, or who is related to a person (other than you) having such an interest. 

Recourse loans: The lender may pursue a judgment for a default on a note not only against the property underlying the note, but also against the party or parties signing the note.

Nonrecourse loans: The borrower is not personally liable on the loan.

The lender must look to other security for repayment. In nonrecourse financing, only the property used as collateral for the underlying loan may be reached to satisfy a default judgment.

Adjusting Your Loan Basis

You must adjust your loan basis at the end of each tax year. After making the adjustments, the final result is your adjusted loan basis.

Items that increase or decrease your loan basis:

  • INCREASE YOUR LOAN BASIS BY:
    • Additional loans to the corporation
    • Deferred (unpaid) interest added to the loan
  • DECREASE YOUR LOAN BASIS BY:
    • Repayments of principal
    • Debt forgiven by you
    • Principal amount of a loan converted to stock
    • Your share of net loss in excess of the adjusted basis in your stock

Example:

Loss deducted up to tax basis.

  • You invest $5,000 in cash in your S corporation.
  • You make a direct loan of $10,000 to the business.
  • You materially participate in the business.
  • At year-end, the business has a net loss of $20,000.

You may deduct $15,000, the amount of your tax basis (cash, $5,000 plus your direct loan of $10,000).

The excess loss of $5,000 cannot be deducted this year. The excess loss is called a suspended loss and is carried over to the following year, or until you restore your tax basis to cover the loss.

Had the $10,000 loan been a nonrecourse loan (this means you have no personal liability if the loan doesn't get repaid) your deduction would have been limited to $5,000, the amount of your cash investment.

Your suspended loss would have been $15,000.

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