Key Takeaways

  • Debt Basis in an S Corp reflects the loans shareholders make to the corporation. It’s crucial for calculating tax deductions and losses.
  • Stock Basis and Debt Basis interact but are measured differently—stock basis involves the shareholder's investment, while debt basis reflects the loan amount.
  • Correct basis calculation ensures shareholders avoid tax issues and maximize the ability to deduct losses.
  • Shareholder loans to an S Corp are essential for tax planning, especially for managing losses and maximizing deductions.

​Debt Basis S Corporation

Measuring a debt basis of an S corporation is complex, but important for certain tax purposes. S Corporations are those entities that have less than 100 shareholders and can choose to be taxed as a partnership, rather than a corporation. The tax benefits of a partnership include only being taxed once on the year’s profits, where the shareholders pay tax on their portion of the partnership’s earnings.

What is a Basis?

A basis is a measure for taxing shareholder transactions with the corporation. Each shareholder in an S corporation has a “basis” which measures their after-tax investment in the corporation. Each year, the corporation issues a Schedule K-1 to each shareholder, which includes the corporation’s income, loss and deduction that are owed to that shareholder.

A Schedule K-1 will not include the distribution amount that will be taxed. That number depends on how much stock the shareholder owns in the corporation. The corporation itself is not responsible for keeping track of a shareholder’s stock and debt basis. Rather, the shareholder’s public accountant should determine basis each year to prep for their personal tax returns.

It is important for a shareholder to track his or her basis for a number of reasons:

• To determine gains or losses on any stock sale;

• If the corporation owes any losses to a shareholder, to determine the loss amount the shareholder can use and how much must be suspended or carried over;

• To determine which distributions from the corporation are taxable.

It is advisable that a shareholder, especially those in small S corporations, obtain some sort of tax preparation before the end of a year.

What is a Stock Basis?

A stock basis is measured based on how much the shareholder invested in the corporation. To calculate a stock basis, you must first know how much money and property the shareholder contributed to the corporation when he or she started employment. Every year thereafter, the stock basis increases by the amount of income—including regular income, tax-exempt income, and excess depletion—the shareholder reports on his or her taxes. The stock basis decreases by the shareholder’s share of the corporation’s losses as well as nondeductible expenses. Furthermore, any additional expenses the shareholder transfers to the corporation will increase his or her basis, and any expenses the stockholder gets from the corporation will decrease his or her basis.

The proper order for determining a stock basis is the following:

1. Increase basis by income (general, nonexempt, etc.). This should be reported on the Schedule K-1 form.

2. Decrease basis by the amount of cash and property the corporation distributed to the shareholder. This should be reported on the Schedule K-1 form, box 16, code D.

3. Decrease basis by the nondeductible expenditures

4. Decrease basis by all deductible losses and deductions report on the Schedule K-1 form.

What is a Debt Basis?

Measuring a shareholder’s debt basis is similar to measuring a stock basis. To calculate a debt basis, you take the original amount the stockholder loaned to the corporation and increase his or her basis for that loan and any additional loans he or she provided. Then, the debt basis will decrease when the corporation pays off any of that debt or if the stockholder’s share of the corporation’s losses is larger than his or her shares.

The proper order for determining a debt basis is the following:

1. Begin with the original loan granted to the corporation

2. Increase basis by the loans made to the corporation, including interest

3. Decrease basis by any payments the corporation made on the loan

4. Decrease basis by any losses or deductions that were larger than the shareholder’s basis of shares.

A few things to keep in mind when calculating a debt basis:

• A basis can never be decreased to an amount below zero.

• Losses can be carried over into future years

• If no debt exists at the beginning of the year, then the basis amount at the beginning of the year is zero, which can then be adjusted by any losses or deductions from previous years.

What is the Impact of Debt Basis on Tax Deductions?

When calculating a debt basis, shareholders in S Corporations must track the loans they make to the corporation, as these loans can influence their ability to deduct corporate losses. Specifically, if an S Corporation incurs losses, shareholders can use their debt basis to offset those losses, reducing their taxable income. It is critical to remember that the debt basis does not carry the same restrictions as stock basis. Losses can be deducted up to the amount of debt basis, making it a key tool for shareholders to manage taxes effectively.

Furthermore, for the debt to qualify for basis, it must be considered "bona fide debt." This means the loan must be an actual debt obligation, with terms clearly defined, including repayment schedules and interest rates. Without this, the loan cannot increase the debt basis and will not count towards tax deductions.

For example, if a shareholder loans $50,000 to the S Corporation and the corporation later experiences a $30,000 loss, the shareholder can use the $50,000 debt basis to deduct up to $30,000 of that loss. However, if the loan is repaid or if additional losses exceed the debt basis, no further deductions can be taken for that year.

Adjusting Debt Basis Over Time

Just like stock basis, a debt basis must be adjusted every year. This adjustment occurs based on additional loans, repayments, and the corporation’s financial performance.

  • Increase in Basis: If a shareholder lends more money to the corporation or if the corporation earns income that increases the debt basis, this will raise the shareholder’s debt basis.
  • Decrease in Basis: The basis will decrease if the corporation repays any of the loan, or if the corporation has deductions or losses that exceed the shareholder’s share of the corporation’s stock. In these cases, the decrease in debt basis can limit the shareholder’s ability to deduct future losses.

It’s also important to remember that the debt basis cannot go below zero. Once the debt basis is zero, any additional losses or deductions will not benefit the shareholder until the debt basis is increased again through new loans or income.

Frequently Asked Questions

  1. What is the difference between stock basis and debt basis?
    Stock basis represents the shareholder’s investment in the corporation, while debt basis reflects loans made by the shareholder to the corporation. Both impact tax deductions but are calculated differently.
  2. How does debt basis impact tax deductions?
    Debt basis allows shareholders to deduct losses passed through from the corporation, up to the amount of the loan they made to the corporation. If the debt basis is depleted, no further deductions can be claimed.
  3. Can debt basis be negative?
    No, debt basis cannot be reduced below zero. Once the debt basis hits zero, additional losses or deductions cannot be claimed until the basis is increased again.
  4. How do I calculate my debt basis?
    Start with the initial loan, increase the basis with any additional loans or interest, and decrease it when the corporation repays any part of the loan or incurs more losses than the shareholder's stock share.
  5. What qualifies as "bona fide debt" for debt basis purposes?
    Bona fide debt must be a legitimate loan agreement with terms for repayment, including a fixed interest rate and a clear repayment schedule. Without these terms, the debt will not count towards increasing the debt basis.

If you need help with determining what is debt basis, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.