S Corp Basis Calculation: Everything You Need to Know
S corp basis calculation refers to the amount the owner has invested in the business or property. 3 min read
The Basics of S Corporation Stock Basis
S corp basis calculation refers to the amount the owner has invested in the business or property. When the investor first makes an investment in the business, this is the initial cost of the property. However, as an S corporation grows or scales back, the basis calculation can change as the investment of the shareholder shifts.
This is something that sets S corporations apart from C corporations, as the stock basis of a C corp remains the same each year. The basis calculation of an S corporation can change, based on factors such as:
- Annual income
These shifts can be surprising to shareholders and managers in an S corp. When calculating the basis for each shareholder, it's important to make sure that it is handled accurately. This figure measures how much a shareholder can receive or withdraw from the S corporation without tracking the gain or income. Each shareholder's basis represents their economic investment in the business.
The calculations and adjustments for stock basis should happen at the end of the taxable year. These figures should include any losses, deductions, distributions, and account income. It's also important to calculate each amount in the correct order to get the right number.
Many companies overlook or neglect the task of tracking the basis calculation. This may happen because the company is becoming more profitable but making minimal distributions, so the number isn't as important to the shareholders. However, the need to keep accurate calculations will become more critical when a change occurs, such as the company reaches the end of its life or a shareholder alters their ownership interest. When people start a new business venture or invest in a company, they typically don't consider what will happen when it comes to an end.
When the shareholders of a corporation don't keep track of the basis calculation on an ongoing basis, trying to do it after the fact is challenging and tedious. In fact, the process can feel a bit like trying to put a puzzle together without having all the necessary pieces. In some cases, the accountant for the business will keep track of the basis calculation when preparing company or shareholder tax returns.
A CPA assigned to handle the financials for a corporation can help clients by tracking the basis calculation from the day the business starts. In some cases, a CPA may come in after the fact, which means they could come into a poorly managed system for basis calculations. The basis is a number that will go up and down as the company engages in different business activities.
The ultimate purpose of this number is to determine whether losses are deductible or distributions are subject to tax. Each shareholder's basis should be tracked from the start of the formation of the corporation and continue to be calculated every year. The two main basis numbers that should be tracked are debt basis and stock basis.
Items of Adjustment
Understanding stock basis and explaining it to any clients can be challenging. Comparing it to a checking account can make it clearer. The stock basis includes the earnings and deposits, minus any withdrawals. Similar to a bank account, shareholders and managers can't take out more money than what is coming in. The stock basis can't dip below a positive level. The stock basis starts as soon as a corporation is formed and starts doing business, so it's critical to track it at the start of the business.
When the basis is tracked and updated every year, it becomes a less complex and more straightforward process. In fact, it's simple enough to use standard tax preparation software or calculate it manually. In the beginning, the initial basis is typically the amount of cash that was paid for shares in the S corporation. It can also refer to the basis of stock in a C corporation when it converts to an S corporation, the stepped-up basis if the stock was inherited, the carryover basis if the stock was gifted, or how much property was contributed to the business.
Some of the increases commonly used to calculate stock basis include:
- Non-deductible distributions and expenses
- Capital contributions
- Charitable contributions
- Ordinary income
- Section 179 deductions
- Investment gains and income
- Common decreases
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