Why do shareholders in an S Corporation care about their stock basis and debt basis? A shareholder’s basis in the S Corporation stock or debt is very important for multiple reasons. The article below has been prepared by a tax attorney and business attorney at The McGuire Law Firm to provide additional information regarding the above issue. Please remember to always consult your tax or business attorney regarding your specific issues.
S corporation shareholders may be limited to the amount of loss they can claim. Even if the K-1 issued to the shareholder shows a loss, this does not necessarily mean the shareholder can claim the loss on their 1040 individual income tax return. There are three loss limitations to a shareholder of an S corporation. These loss limitations are as follows: 1) At risk limitations; 2) Stock Basis and Debt Basis Limitation; and. 3) Passive Activity Loss Limitations. Each limitation must be met, starting with a shareholder’s stock basis and debt basis in the S corporation stock for a shareholder to claim a pass through loss. This article will discuss stock and debt basis.
Unlike a C corporation, a shareholder of an S corporation will recognize an increase or a decrease in their stock basis each year based upon the operations of the corporation, which is related to the K-1 that is issued to the shareholder. The shareholder is responsible for tracking their S corporation stock basis, not the corporation. The K-1 that is issued to the taxpayer will show the amount of non-dividend distributions that the shareholder has received, but does not state the taxable amount of the distribution. The taxable amount of a distribution is dictated by the shareholder’s basis stock basis. If a shareholder receives a non-dividend distribution from an S corporation, the distribution can be tax free to the extent of the shareholder’s stock basis. If the shareholder has a stock basis in excess of the non-dividend distribution, the distribution may be tax free.
If a loss is allocated to the shareholder, the shareholder must have sufficient stock basis (or potentially debt basis) to claim the loss or deduction on their 1040 individual income tax return. Thus, a shareholder’s stock and/or debt basis in the S corporation can dictated whether or not or how much of a loss or deduction can be taken by the shareholder and is why a shareholder should care about their basis. Furthermore, such basis also provides the amount by which the shareholder can take a non-dividend distribution tax free. In later articles, we will discuss how such stock basis is computed and other related issues.
If you have questions related to your S corporation you can speak with a Denver tax attorney and business attorney by contacting The McGuire Law Firm. A free consultation is provided to all potential clients.