S Corp Distributions and Stock Basis
I'm confused about the relationship between distributions and the S corp stock basis. I have a S corp that has been profitable for the first 3 years but had a loss for 2006. In doing my personal taxes I came across something about my K-1 loss may be limited by my stock basis. I read the K-1 instructions and did the worksheet to figure my stock basis (as near as I could decipher the instructions). The net result is my loss in 2006 exceeds my stock basis at the end of 2006.
As I understand it, this means I can only take the amount of loss (on 2006 return) that would result in a stock basis of zero. Okay, that's fine, but elsewhere I read that distributions in excess of the stock basis are considered taxable???
I really don't get it. What is the connection between stock basis and taxes? When the S corp ends, is the stock basis used to calculate a gain based on the original cost of the stock? If I don't sell the S corp, just quit doing business, is it still a gain?
In 2010, the United States
In 2010, the United States Government Accountability Office (GAO) issued a report to the U.S. Senate Finance Committee titled "TAX GAP: Actions Needed to Address Noncompliance with S Corporation Tax Rules." The report examined how well S-corporations and their shareholders accurately reported income and expenses. The study also addressed the difficulty shareholders have in understanding and calculating shareholder basis. Finally, the report examined employee salaries paid to shareholders and how Social Security and Medicare taxes are affected by allowing S corporations to treat only a portion of withdrawn income as salary. Portable Storage Bloodborne Pathogen Training
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If the current year has
If the current year has different types of losses and deductions, which exceed stock and debt basis, the allowable losses and deductions must be allocated pro rata based on the size of the particular loss and deduction items Business Ideas.
A shareholder is not allowed to claim losses and deductions in excess of stock and debt basis. Losses and deductions not allowable in the current year are suspended due to basis limitations Business Strategy.
Suspended losses and deductions due to basis limitations retain their character in subsequent years. Any suspended losses or deductions in excess of stock and debt basis are carried forward indefinitely until basis is increased in subsequent years or the shareholder disposes of the stock
S Corp Stock Loss
The S-Corp winds up and dissolves. The shareholders each have some remaining basis. What is the nature of the loss? Just a long term capital loss? one shareholder was an original issue stock owner, so should be section 1244, but the other two bought in later?
Thanks for your thoughts.
Claude
S Corp Losses
Hi Claude.
Think of it as purchasing stock on the open market over time. Say you purchase $100 of stock on the last day of the year each year for 10 years. You have $1000 of basis. You sold all the stock of the Dec 1 on the 11th year for $800.
You have a $200 loss of which $20 is short term, the rest is long term.
The same idea applies for the S Corp. Each year you have taxable income you add to the basis of your S stock. If you didn't have any profit to add to basis in the last year then it's likely that the entire loss is long-term. If not, the it will depend on when you had profits that added basis to your basis and when the S corp dissolves.
L:)
S-Corp Basis
Hi taxnewbie,
This is a problem that vexes many, not just newbies. :) The instructions for this part of the 1120S are about as clear as mud.
The trick to understanding what's going here with basis & taxes is to think about your basis as what money have you already paid taxes on. When you originally fund the S-Corp, you had previously paid taxes on that money you put in. So that increases your basis. Likewise when you have a gain you pay personal tax on it & that increases your basis. When you have a loss its used to reduce your otherwise taxable income. So it reduces your basis. And with distributions, you're taking out money or property that you've paid taxes on so that reduces your basis. With me?
Ok. So let's say you dissolve your S-Corp and the cash balance is greater than your basis. First off, this isn't likely to happen if you're a cash basis tax payer. Anyway, in this case you're taking out money that you haven't paid tax on yet. In that case you have to pay tax on that money. The good news is you pay capital gains tax rates rather than ordinary income rates.
I hope this helps a little. This is a really hard one to explain & this is quite a simplification. :) 179 Depreciation & tax-free interest income complicates the example above surprisingly quickly.
L:)
S-corp distributions
While I understand that S-corp profits flow through to the shareholders on a K-1. Can we make a disproportionate distribution to the shareholder/manager (60% owner), or do we have to distribute per the ownership percentages?
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your comments are brilliantly clear and helpful!
just thought you should know that.
Hi Linda, Thanks for the
Hi Linda,
Thanks for the explanation. I think I understand basis now.
Regarding the 179 comment, I included the 179 deductions as part of the worksheet calculation to determine my stock basis, so I'm assuming that I can still take the 179 deduction on my personal 2006 tax return. Or is there something else that prevent this?
Also, the stock basis worksheet includes "non-deductible expenses" but these expenses do not get passed through to my personal taxes, so why are these expenses used to reduce my stock basis?
Thanks,
Taxnewbie
Stock Basis Details...
Good question... These are the basis issues I try to avoid because they're even more confusing than the rest of it. :)
Tax-exempt interest income increases your basis because it is like a gain (money in). Likewise non-deductible expenses reduce your basis because it is like a loss (money out). Both of these items are outside the tax structure and don't affect your taxes. But they do affect your financial position in the company nonetheless.
Regarding the 179 expense, you can only deduct the 179 in the current year to the extent you have business profit. If you take it and you have a loss in 2006 you'll get a carryforward of the 179 to next year.
Hope this helps.
L:)
I took into account
I took into account deducting the 179 on my 2006 1040 when I calculated how much loss I can take on my 2006 1040. Basically I reduced my 2006 1040 loss such that my tax basis is now zero.
So, can I still take the 179 and the (reduced) loss on my 2006 1040?
Thanks,
Taxnewbie
179 Expense limit by business income
No. You wont be able to take the portion of the 179 expense that puts you in to a loss.
You don't have to make the 179 election on 100% of the cost of an asset. Say you bought something for $10,000 but you only have $6,000 of income. You can take $6,000 of 179 and then normally depreciate the remaining $4,000. Otherwise if you try to take all $10K, $4k will be carried forward to 2007.
L:)
Hi Linda, I'm still
Hi Linda, I'm still confused. Are you talking about the 1120S return? Are you saying you can't take the 179 election if you have a loss?
Thanks,
Taxnewbie
179 Expense limits
Yes this applies to all returns...
The nice thing is if you or spouse (if filing joint) can include W-2 wages in your taxable income. If there's no other ordinary income other than the S-Corp, then you're limited to the total 179 deduction you can take.
Special rules apply to autos that may also limit the 179 amount you can deduct.
L:)
I had W-2 wages from my S
I had W-2 wages from my S corp. The wages and federal w/h exceed the amount of the 179. I used TurboTax for Business to do the 1120S and it did not flag the 179 deduction. In fact, it created the K-1 form that shows a net loss and the 179 deduction. So two questions:
1) Is my 1120S return wrong?
2) Can I use the 179 deduction on my 2006 1040?
Thanks Again,
Taxnewbie
As usual, it depends...
1. Not necessarily. I can't see it so it's hard to say for sure. :)
2. Probably. When you enter the K-1 in TurboTax it will determine if you can take the deduction. If your W-2 wages was greater than the 179 then most likely yes you can take it. It all depends on the specifics of your particular return. :)
L:)
Hi Linda. Thanks for your
Hi Linda. Thanks for your help. Sorry to have droned on and on but it seems that taxes are like that. I'm not a financial type and this stuff is just hard to understand. I've tried reading the IRS publications but they tend to be written in a very technical fashion that leaves a lot to be desired for people not well-versed in these matters.
At any rate, thanks again.
Taxnewbie
IRS Publications
If you think the publications are technical, try reading Federal Tax Regulations or the Internal Revenue Code sections governing these issues. The pubs are much easier.
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