1. Importance of Basis
2. Two Types of Basis
3. How Basis Is Calculated

Updated July 14, 2020:

An S corp basis worksheet is used to compute a shareholder's basis in an S corporation. 

Shareholders who have ownership in an S corporation must make a point to have a general understanding of basis. The amount that the property's owner has invested into the property is considered the basis. This basis fluctuates with changes in the company. 

According to the IRS, basis is the amount of the shareholder's investment in the business for tax purposes. Initially, the basis is the cost of the property, but in an S corporation, the basis can change as a shareholder's investment changes. While a C corporation stock basis stays the same each year, an S corporation basis can change due to annual income, distributions, and loans.

Upon the filing of the S corporation's tax return (1120S), shareholders will receive a K-1 form providing their allocated profits, losses, and deductions. The taxable amount of the distribution is not included on the K-1 form because it is dependent on the stock basis.

The primary reason for basis is to determine the taxability and deductibility of distributions and losses. Annually, a shareholder's basis is individually calculated and must be followed from the start of ownership.

Importance of Basis

In order to report pass-through losses or deductions, shareholders must first verify that they have enough basis in the S corporation. If distributions received are fully covered by shareholders' basis, then they do not have to report the distribution as taxable income. Losses are permitted to be deducted in the current tax year if the shareholder has enough basis to cover the amount of the loss.

Basis is also used in determining the gain or loss on a shareholder's disposal of stock. Additionally, basis is taken into account when the company has a change in ownership.

Two Types of Basis

There are two types of basis numbers that must be followed: 

  • Stock basis
  • Debt basis

A debt basis is acquired if the shareholder makes a direct loan to the corporation. In doing so, the shareholder takes on a certain level of risk.

Loan basis begins with a loan that is supported by documentation provided by the shareholder to the S corporation. This documentation includes a standard written note with a fair interest rate. Third-party loans are not included.

How Basis Is Calculated

It is important that the shareholder's basis in the S corporation be calculated accurately because it is used to determine the amount the shareholder can withdraw or receive from the company without being required to recognize income. This basis ought to mirror the shareholder's investment in the corporation.

It can be helpful to look at basis as a checking account. A deposit of income causes the basis to go up based on the shareholder's percentage of ownership. An expense causes the basis to decrease. If a shareholder gives money to the corporation, the basis goes up, and if a shareholder withdraws money, the basis goes down.

The following activities can also cause a decrease in the basis:

  • Section 179 deductions on assets
  • Penalties paid by the company
  • Non-deductible amounts of meals and entertainment

Basis begins at zero in the first year. The ending basis of that year is determined by the business activity throughout that year. The basis at the end of year one provides shareholders with a beginning basis for year two. 

Any adjustments to the basis should be made at the end of each taxable year, making sure to correctly include the following:

  • Income
  • Distributions
  • Deductions
  • Losses

Shareholders or partners can claim a deduction of company losses on their tax returns to the degree of their current basis. If the individual does not have a basis, those losses will either be suspended or carried forward to balance out future income or basis. If shareholders are uncertain of or incorrectly recorded their basis, they could unintentionally deduct inaccurate losses. 

It is important to note that credits are not limited to basis, so while shareholders cannot benefit from a loss without basis, they can take advantage of a credit. Occasionally, credits can affect basis, so it is critical that shareholders thoroughly study the rules concerning credits.

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