S Corp Shareholder Basis: Everything You Need to Know
S corp shareholder basis is a measure of the amount that a shareholder has invested in an S corporation. 3 min read
S corp shareholder basis is a measure of the amount that a shareholder has invested in an S corporation. While the concept of an S corporation's shareholder basis is fairly simple, many CPA tax practitioners find it tedious to calculate basis for the stock of S corporations. Here is everything you need to know about the shareholder basis for S corporations.
S Corporation Shareholder Basis: General Definition
The double taxation regime is the hallmark of subchapter C. Income that is earned by a C corporation is taxed at the entity level first. If the C corporation opts to distribute the income among the shareholders, the shareholders will then have to pay taxes on the income received as dividends. As a result, the income is taxed twice, once at the corporate level and once at the personal level.
If the corporation chooses to keep the income and the value of the stock of the shareholders increases, the shareholder will still end up paying taxes on this income a second time. This tax will come in the form of capital gains on the stock's disposition.
On the other hand, S corporations are subject to only one level of taxation. Therefore, when an S corporation produces income, the corporation doesn't need to pay taxes on this income at the corporate or entity level (be aware that there are exceptions to this rule described in sections 1374 and 1375). Instead, the income is allocated among the shareholders of the corporation. The shareholders are responsible for reporting the income on their individual returns and paying taxes on this income.
The shareholders of an S corporation can't assume that company losses passed through are automatically deductible from their personal income tax returns. Whether a shareholder possesses enough basis in the S corporation will determine whether he can deduct the losses from his individual tax returns.
Anyone who has ownership of any kind in an S corporation needs to have a good understanding of the concept of basis as it relates to taxes. Basis, which is a number, increases and decreases depending on the activity of the company. In the eyes of the Internal Revenue Service (IRS), basis is the amount of an individual's investment in an entity.
When an S corporation files 1120S, which is a tax return, every single shareholder will receive a K-1 form. The purpose of the K-1 form is to show profits, deductions, and losses distributed to a shareholder. The K-1 does not indicate the amount of the distribution that is taxable. This amount depends on the stock basis of the shareholder.
The main purpose of the stock basis is to help determine whether distributions are taxable and whether losses can be deducted. The stock basis for every shareholder is calculated once per year. The basis of a shareholder must be tracked from the first day of ownership.
Some reasons for the importance of calculating basis include the following:
- If the shareholder gets a distribution and doesn't have any basis to cover the amount, the withdrawal will not be taxable for the shareholder.
- If the shareholder possesses a loss in the S corporation and doesn't have enough basis to cover the loss, the losses can be taken the same tax year.
- When the shareholder gets rid of his or her stock, the loss or gain on the disposition is calculated using the stock basis of the shareholder.
How Basis is Calculated
If the S corporation allocates the income, neither the sale nor the distribution of the shareholder stock will cause the income of the S corporation to be taxed twice. This is also true if the corporation chooses to keep the income and increase the value of the stock of the shareholders. Section 1366's basic adjustment rules act as a mechanism for preserving the single level of taxation that S corporations enjoy. These rules accomplish this by making sure the distribution of the income of an S corporation or the sale of shareholder stock doesn't lead to a second level of taxation.
A shareholder is able to acquire basis of an S corporation by purchasing stock. Cumulative net income and additional equity contributions also have an impact on the ability of a shareholder to acquire stock. Shareholders can also obtain basis in the form of debt by making loans to the S corporation. It is essential to keep in mind that non-dividend distributions don't reduce debt basis but do reduce stock basis.
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