Deducting S corporation losses to extent of shareholder basis.

• Author: Ellentuck, Albert B.

AN S CORPORATION SHAREHOLDER REPORTS corporate income or loss on the personal income tax return for the year in which the corporate year ends (Sec. 1366(a)). Losses or deductions passed through to the shareholder first reduce stock basis. After stock basis has been reduced to zero, remaining loss amounts are applied against debt basis (Sec. 1367(b)(2)(A)). Debt basis is not reduced by passthrough losses or deductions if the debt has been satisfied, disposed of, or forgiven during the corporation's tax year (Regs. Sec. 1.1367-2(b)). A "net increase" first restores debt basis to the extent debt basis has been reduced by losses or deductions in tax years beginning after 1982 (Sec. 1367(b)(2)(B); Regs. Sec. 1.1367-2(c)(1)). A "net increase" is, generally, the amount by which the sum of passthrough income and gains exceeds the sum of passthrough loss, deductions, and distributions.

Example 1: B Inc., a calendar-year corporation, was formed on Jan. 1, 2010. At formation, P contributed $50,000 in exchange for 100% of B's stock and loaned $45,000 to the corporation. The corporation's nonseparately stated (taxable) income or loss for each year is shown in Exhibit 1. The corporation had no other income or expense items. No loan payments were made to P, and P did not contribute additional capital to the corporation. B distributed $100,000 to P in 2012. Is P's basis adequate to permit full deduction of corporate losses? P's basis is shown in Exhibit 2.

Exhibit 1: Nonseparately stated (taxable) income or loss in Example 1 Year Income (Loss) 2010 $(63,000) 2011 42,000 2012 119,000 Exhibit 2: P's basis in Example 1 Year Explanation Stock Basis Debt Basis 2010 Beginning balances $50,000 S45,000 Loss--reduce stock basis (50,000) Loss--reduce debt basis -- (13,000) Ending balances - 32,000 2011 Income--increase debt basis 13,000 Income--increase stock basis 29 000 -- Ending balances 29,000 45,000 2012 Income--increase stock basis 119,000 - Distributions--decrease stock basis (100,000) -- Ending balances $48,000 $45,000 P has stock basis of $48,000 (after taking into account distributions to P of $100,000 during the year) and debt basis of $45,000 at the end of 2012. Each loss was fully deductible in the year it occurred because P had sufficient basis in stock and debt to cover the loss.

Planning to Obtain Additional Basis

In a year losses decrease stock and debt basis to zero, the losses can be deducted in that year only if the shareholder increases basis...