S Corp Capital Gains: Everything You Need to Know
S corp capital gains refer to increases in the value of an S corporation's capital assets, such as stocks, bonds, or properties. 4 min read
2. S Corp Accounting for Shareholder Capital
3. Investing Cash and Property
4. What Is Shareholder's Basis?
5. What Is Adjusted Basis?
6. What Is Loan Basis?
7. Capital Gains Tax on Stock Sale
Updated October 29, 2020:
S corp capital gains refer to increases in the value of an S corporation's capital assets, such as stocks, bonds, or properties. An S corp is an entity that allows its earnings, deductions, and credits to pass through to its shareholders to be taxed at an individual level. When a non-dividend distribution is given to a shareholder, it is tax-free as long as it does not exceed his or her stock basis. If it exceeds the stock basis, the excess amount will be regarded as a capital gain.
S Corp Income and Expense Accounting
S corp accounting is somewhat similar to C corp accounting. An S corporation's earnings and expenses are reported at the company level. They will keep their character as they pass through to the personal income tax returns of the shareholders. For instance, long-term capital gains will remain long-term capital gains after they reach the individual level. In order to help its shareholders report their taxes correctly, an S corporation must be able to identify different types of incomes and expenses.
S Corp Accounting for Shareholder Capital
One of the main problems that an S corporation faces is accounting for each shareholder's capital account. It must maintain detailed and accurate records of its shareholders' equity investments of property and cash and the loans they advance to the company. Shareholders of an S corp are required to divide the company's net income in exact proportion to their ownership shares. For instance, if a shareholder's investment makes up one-third of the S corporation's capital, he or she will receive exactly one-third of the corporation's net profit or loss.
The capital accounts play a significant role in two crucial aspects of an S corp's financial and tax reporting. First, they are reported as shareholder equity or loans from shareholders on the balance sheets. Second, the capital account of each shareholder may be summarized on IRS Form 1120S Schedule K-1. If there is a lack of capital investments, shareholders may fail to comply with the At-Risk rules for S corp losses, and losses may then become non-deductible.
Investing Cash and Property
Shareholders can invest property or cash in their S corporation. They may also contribute the following items in addition to their investments:
- Software programs
- Reference books
- Other items
The value of a shareholder's property is the lower of either the property's fair market value or the adjusted basis in the property.
What Is Shareholder's Basis?
According to the IRS, stock basis is the sum of a shareholder's capital investment. Typically, it is the amount a shareholder paid in cash, property, services, or debt obligations. The stock basis can fluctuate yearly dollar-for-dollar based on the allocation of undrawn profits.
The capital account of a shareholder must reflect his or her investments and basis in the company's equity and liabilities for the current year. A shareholder is invested in an S corp to the extent that he or she has contributed equity or offered a loan to the company. The value of the property and the amount of cash investments donated to the corporation will be shown in the capital account.
What Is Adjusted Basis?
The capital account is occasionally adjusted to show additional equity investments. Also, it undergoes adjustment at the end of the year to show the pro-rata income and expense share of each shareholder.
What Is Loan Basis?
A shareholder can advance loans to an S corporation. For instance, a shareholder can use his or her personal credit card to pay for company expenses and then submit an expense report for repayment. A loan to an S corp can be a short-term loan that has to be repaid in a year or less or a long-term loan that can be repaid in more than a year. A shareholder who makes a loan to an S corporation is eligible for a tax deduction for losses that exceed his or her stock basis.
Capital Gains Tax on Stock Sale
The stock basis of an S corp shareholder determines the capital gains tax on stock sale. In a straight stock sale, the capital gains tax liability is equal to each shareholder's allocation of the company's purchase price minus his or her current stock basis and the sale's transaction costs. Since a shareholder's stock basis can fluctuate frequently, he or she should hire financial consultants to recalculate the basis yearly to prevent errors.
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