The Simple Concept of Basis for S Corporation Stock

  • Accracy
  • 26th Nov, 2023

One of your many decisions as a small business owner is whether to incorporate. If you do, you'll need to designate your company — the Internal Revenue Service views all incorporated businesses as C corporations by default. However, it may make more sense to classify your business as an S corporation. Here is a comparison of C corp and S corp pros and cons.

The Simple Concept of Basis for S Corporation Stock
Tax Tips

Both S corp and C corp businesses have a shareholder basis, also sometimes called a stock and debt basis. Per the IRS, this shareholder basis is your capital investment in a property for tax purposes. In this case, your business is the property.

The C corporation shareholder basis remains the same yearly, so it's simpler to calculate. S corp basis will vary depending on different decisions and factors. The one from this year almost certainly won't be the same as a prior year. An S corp stock basis starts as soon as your company begins doing business, and it's essential to accurately track it.

 

How to calculate shareholder basis for an S Corporation

Your shareholder basis is your company's earnings and deposits minus withdrawals. Think of your stock basis like a bank account. You can't take out more money than you have — the stock basis must always remain above $0.

Typically, your initial stock basis is what you paid in cash for shares in the S corporation. It can also be the basis of stock in a C corp before converting to an S corp. You might have inherited the stock or received it as a gift; in that case, the initial deposit will be the stepped-up basis or the carryover basis, respectively.

There are several sources to consider when calculating your stock basis. Common ones include capital contributions, ordinary income, investment gains and income, and charitable contributions.

Here's how you can use your Schedule K-1 (Form 1120) to determine your stock basis:

  • First, start with your initial capital contribution or cost of the purchased stock.
  • Add your ordinary income from Box 1. If you have a loss, we'll come back to this box.
  • Add other taxable income from Boxes 2-12, such as interest income, ordinary dividends, or short- and long-term capital gains.
  • Add tax-exempt income in Box 16A and 16B. This income includes distributions from Roth IRAs and Roth 401(k)s, municipal bonds, and most benefits from company health insurance plans.
  • Add excess depletion in Box 15C. This box is primarily used by companies in the oil and gas industry that use natural resources.
  • Once you've added those, it's time to subtract any losses.
  • Subtract separately stated loss items in Box 2-12S.
  • Subtract nondeductible expenses in Box 16C, such as everyday travel and entertainment expenses.
  • Subtract non-dividend distributions in Box 16D.
  • Subtract depletion for oil and gas in Box 17R.

You'll now have your stock basis before loss and deduction items. If you have a loss in Box 1, subtract it from the current total. You'll also need to subtract any charitable donations.

Increasing the S corporation stock basis first before decreasing it is the preferred method since you'll more easily be able to see if your stock basis will dip below $0. In that case, loss and deduction items will exceed the shareholder's basis, so you'll have to calculate your debt basis.

Debt basis comes into play when a shareholder has loaned money to the S corporation. You'll take what the stockholder initially loaned to the corporation and increase their basis for any additional loans, including interest. You'll then decrease the basis by payments the corporation makes on the loan. Finally, decrease the basis by losses or deductions that are larger than the shareholder's basis of shares.

Remember, you can't decrease a basis to anything below $0. If you have losses, you can carry them over into the next year. Those losses are treated as being incurred in the following tax year, but can only be deducted after you increase the basis.

Once you've determined your stock and debt basis, you can calculate your entire shareholder basis using Form 7203.

An example of S corporation shareholder basis

This process can get rather complicated, so it's helpful to see an example. Say your initial capital contribution was $20,000, and you had items on your K-1 that looked like this:

 
Box 1 (12,000) Ordinary business income (loss)
Box 5a 3,000 Ordinary dividends
Box 12A 4,000 Charitable cash contributions
Box 16C  2,000 Nondeductible expenses
Box 16D 8,000  Distributions

First, you'd increase the your initial contribution of $20,000—the starting stock basis—by the $3,000 from ordinary dividends. You'd then take that $23,000 and decrease the basis by subtracting the distributions ($23,000 - $8,000 = $15,000). Then, decrease the remaining $15,000 by $2,000 for nondeductible expenses.

Your current total is now $13,000, which is your stock basis before loss and deduction items. However, the deductions and losses surpass that amount — $12,000 in ordinary loss and $4,000 in charitable contributions, for a total of $16,000.

If there's debt basis, you can apply it here. If not, you can use a formula to get your stock basis back to zero. You'll simply take your ordinary loss and charitable contribution numbers and divide by the total of all deduction and loss boxes, then multiply by your stock basis. In this case:

First, you'd increase your initial contribution of $20,000—the starting stock basis—by the $3,000 from ordinary dividends. You'd then take that $23,000 and decrease the basis by subtracting the distributions ($23,000 - $8,000 = $15,000). Next, reduce the remaining $15,000 by $2,000 for nondeductible expenses.

Your current total is now $13,000, which is your stock basis before loss and deduction items. However, the deductions and losses exceed that amount—$12,000 in ordinary loss and $4,000 in charitable contributions, for a total of $16,000.

If there's debt basis, you can apply it here. If not, you can use a formula to get your stock basis back to zero. To do this, divide your ordinary loss and charitable contribution numbers by the total of all deduction and loss boxes, then multiply by your stock basis. In this case:

12,000/16,000 x 13,000 = ($9,750) ordinary loss

4,000/16,000 x 13,000 = $3,250 charitable contribution

If you add up the total loss and deduction items now ($9,750 + $3,250), they also equal $13,000. Your stock basis is now acceptable at $0, and it's what you should report on your tax returns.

On your Schedule E, you'll include $12,000 in the current tax year's ordinary business loss, with $9,750 as your allowable ordinary business loss and $2,250 as the suspended ordinary business loss.

Similarly, on your Schedule A (Form 1040), your cash contribution would be $4,000, but your allowable cash contribution would be $3,250. The remaining $750 would be your suspended cash contribution.

Why S corp basis calculation is important

To take money out of the company for yourself — and to avoid paying tax on shareholder distributions — you'll need to know your shareholder basis so you don't exceed the limit. If you do, you'll pay additional tax on those distributions.

An S corporation avoids double taxation since it typically doesn't pay taxes on income. That income is allocated to shareholders and taxed at an individual taxpayer level, not a corporate one. But shareholder basis lets shareholders know their post-tax investment in an S corp and avoid paying too much tax.

Perhaps some good news as a business owner: It's not the responsibility of the S corp to track stock and debt basis. That calculation falls on the individual shareholder. Of course, you're likely one of those shareholders, so you'll still need to calculate your S corp basis on your income tax return every year.

How to calculate shareholder basis for a C corporation

C corporation owners and shareholders generally aren't as concerned about calculating basis. That's because shareholder tax basis is equal to what was paid for the stock. If the company earns massive revenue and invests it back into the business to grow, the shareholder's tax basis will still be the same as when they first invested.

For example, say a shareholder purchased $25,000 worth of stock in a C corporation in the current year. If the company earns revenue of $500,000 over the next five years that gets reallocated into the business, the shareholder's stock basis will remain at $25,000 in each subsequent year. It doesn't change year-over-year as an S corp shareholder basis does.

The bottom line

Calculating shareholder basis is one of many intricacies of owning a small business. It can be helpful to have a CPA or professional tax advisor on your side.

Our Accracy team is full of experts that can handle your bookkeeping and tax preparation. In running your business, you've got plenty on your plate — let us take worrying about the intricacies of your books and financials off of it.

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