Category: Tax Law

Keeping track of your basis is essential if you own an S corporation. It affects whether you can deduct losses, whether your distributions are tax-free, and how much tax you’ll owe when you sell your stock. Unlike C corporations, where stock basis doesn’t change much, S corp owners see their basis go up and down depending on the company’s income, losses, and distributions.

Two Types of Basis: Stock Basis vs. Debt Basis

As an S corp shareholder, you have two types of basis:

1. Stock Basis – This starts with the amount you paid for your stock or the property value you contributed to the company.
2. Debt Basis – If you personally lend money to the S corp, you get debt basis. (But just guaranteeing a loan from a bank? That doesn’t count.)

You need stock or debt basis to deduct losses, and your basis also determines if distributions are tax-free or taxable.

How Basis Changes Over Time

What Increases Basis?

• Your share of S corp income (both ordinary and separately stated items).
• Tax-exempt income (like municipal bond interest).
• Additional capital contributions you make to the company.

What Decreases Basis? (In This Order)

1. Distributions – These are tax-free until you run out of basis. If you take out more than your basis, the extra amount is taxable as a capital gain (usually long-term if you’ve held the stock for over a year).
2. Nondeductible expenses – Some expenses, like penalties and certain meals, reduce basis even though you can’t deduct them.
3. Losses and deductions – You can only deduct losses if you have enough basis. Any loss that exceeds your basis gets suspended until you get more basis in a future year.

What About Debt Basis?

• If you run out of stock basis but still have debt basis, you can use it to deduct losses.
• Loan repayments reduce debt basis first, which can trigger taxable income if you deducted losses against that debt in prior years.

Example: How Basis Works in Real Life

Let’s say you start an S corp and invest $50,000.

Year 1:

• The S corp earns $30,000.
• You take a $70,000 distribution.

Stock Basis Calculation:

• Starting stock basis: $50,000
• Add income: +30,000 → New basis: $80,000
• Subtract distribution: −70,000
  • Since basis is $80,000, you have enough to cover it, and the distribution is tax-free.
  • New basis: $10,000

Year 2:

• The S corp has a $20,000 loss.
• You take another $15,000 distribution.

Stock Basis Calculation:

• Starting basis: $10,000
• Subtract loss: −10,000 → New basis: $0 (loss limited to available basis).
• Subtract distribution: −15,000
  • Now you’ve gone below zero! The extra $15,000 is taxable as a capital gain.

Key Takeaways

• Distributions are tax-free only up to your basis—anything extra is a capital gain.
• You can’t deduct losses beyond your basis—excess losses get carried forward until basis is restored.
• Loan repayments can be taxable if you’ve used debt basis to deduct losses in the past.
• Keeping good records of your basis will help you avoid unexpected tax surprises!

Basis tracking might not be the most exciting part of owning an S corp, but it’s critical for managing your taxes. Keep an eye on it, and you’ll avoid nasty surprises at tax time.

The IRS is losing workers fast. Buyouts and layoffs gut the agency, leaving fewer employees to handle an already messy tax system. Instead of hiring more staff, why not simplify the tax code so a smaller IRS can manage it? Here are some tax changes that could make life easier for everyone.

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1. Eliminate Business Income Taxes

Corporate taxes don’t come from company profits. Businesses pass them on to consumers through higher prices, workers through lower wages, and shareholders through smaller returns. In reality, business taxes act as a hidden sales tax.

And they’re insanely complicated. Businesses spend billions on compliance, while the IRS wastes resources auditing deductions and chasing tax shelters. Cutting corporate taxes would simplify enforcement, boost the economy, and free up IRS resources. The lost revenue could be replaced with higher individual income taxes or a simple consumption tax.

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2. Get Rid of Tax Credits and Deductions

The tax code is overloaded with credits, deductions, and phase-outs, making filing a nightmare. The fix? Scrap them all—no more complicated calculations—just a straightforward tax on your earnings.

Fewer exceptions mean fewer audits and fewer IRS interventions. A two-tiered or flat tax system would make enforcement even easier.

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3. Automate More Tax Filing

What if most people didn’t have to file taxes at all? Many countries pre-fill returns using employer-reported income. The U.S. could do the same for W-2 earners. Instead of gathering documents and manually entering numbers, taxpayers could just check a pre-filled return and hit submit.

Fewer mistakes, less paperwork, and way less IRS involvement. Win-win.

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4. Cut Down on IRS Customer Service Nightmares

Millions of taxpayers call the IRS every year, stuck on hold for hours. Most issues come from confusing tax rules, outdated notices, and unclear payment systems.

A simpler tax code would mean fewer people need to call. Better online tools could also help taxpayers get answers without waiting on hold forever.

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5. Spread Out the Tax Deadline

The IRS is overwhelmed with returns every February through April 15. A rolling deadline—based on birth month or Social Security number—could spread out the workload, helping a smaller IRS workforce process returns more efficiently.

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The Bottom Line

Instead of expecting an overworked IRS to manage an outdated system, we should fix the system itself. Eliminating business taxes, ditching deductions, automating returns, and reducing IRS interactions would allow a smaller, more efficient agency to function smoothly.

Debt forgiveness can feel like a relief but often comes with an unexpected tax bill. The IRS treats canceled debt as taxable income, which means you may owe taxes on the forgiven amount. Understanding how this works can help you avoid surprises at tax time if you’ve had debt forgiven.

What Is Canceled Debt?

Canceled debt occurs when a lender forgives or discharges part or all of your loan. This can happen with credit card settlements, foreclosures, loan modifications, or student loan forgiveness. The forgiven amount is considered taxable income unless it qualifies for an exception. Lenders issue Form 1099-C to report the canceled amount to the IRS, and you must include it on your tax return.

Why Is It Taxable?

Debt isn’t taxed when you borrow it because you must repay it. However, when the obligation is erased, the forgiven amount is treated as income since it provides a financial benefit.

Exceptions to Taxable Debt

Not all canceled debt is taxable. Key exceptions include:

• Insolvency: If your total debts exceed your assets when the debt is canceled, you may exclude some or all of it from income.
• Bankruptcy: Debt discharged through bankruptcy isn’t taxable.
• Qualified Principal Residence Indebtedness: Forgiven mortgage debt on a primary residence may be excluded under specific rules.
• Certain Student Loans: Forgiveness under specific programs, such as public service, is tax-free.

How to Handle Canceled Debt

1. Check for Exclusions: If an exception applies, such as insolvency or bankruptcy, the canceled debt might not be taxable.
2. File Form 982: Use this form to claim exclusions and reduce taxable income.
3. Plan for Taxes: If the canceled debt is taxable, prepare for the potential tax bill to avoid penalties.
4. Seek Professional Advice: A tax professional can help navigate the rules and exclusions.

Conclusion

Canceled debt may ease financial stress but can create unexpected tax liabilities. If you’ve received a Form 1099-C, don’t ignore it. Understand your options, check for exclusions, and plan accordingly to stay compliant with the IRS and avoid penalties.

The IRS uses specific guidelines based on custody arrangements to determine who can claim a child as a dependent for tax purposes. One key factor that often arises in disputes is where the child spent the majority of nights during the tax year. Understanding these rules is essential for family law attorneys advising clients in divorce and custody cases.

The Majority-of-Nights Rule

The IRS considers the custodial parent as the one who can claim the child as a dependent. The custodial parent is the parent with whom the child spent more than half the nights (183 nights or more) during the calendar year. This rule applies regardless of what a divorce decree or custody agreement may specify.

Here are the basics of how the IRS calculates this:

• Counting Nights: A night is one in which the child sleeps at a parent’s residence, even if the child is temporarily absent due to special circumstances, like illness, school trips, or summer camp.
• Shared Time: If the child spends an equal number of nights with both parents, the IRS will turn to tie-breaker rules, prioritizing the parent with the higher adjusted gross income (AGI).

Exceptions to the Rule

Sometimes, the noncustodial parent may claim the child as a dependent. For this to happen, the following conditions must be met:

1. Custodial Parent Releases Claim: The custodial parent must sign IRS Form 8332, releasing their claim to the dependent.
2. Form Submission: The noncustodial parent must attach Form 8332 to their tax return to claim the child.

Without this signed form, the IRS will default to the custodial parent’s claim, even if the divorce decree assigns dependency to the noncustodial parent.

Common Issues

• Mistakes in Counting Nights: Parents may miscount the number of nights a child spent with them, leading to duplicate claims. This often triggers an IRS audit or denial of both parents’ claims.
• Confusion with Decrees: Many parents assume that the terms of a divorce decree are binding on the IRS. However, the IRS follows its own rules, which can override the decree unless Form 8332 is properly executed.

Tips for Family Law Attorneys

1. Keep Accurate Records: Encourage clients to maintain a calendar or log of where the child spent each night. This is especially important for parents with shared custody arrangements.
2. Address IRS Forms in Agreements: Include provisions in divorce decrees about who will claim the child and ensure the custodial parent agrees to sign Form 8332 if the noncustodial parent is to claim the dependent.
3. Explain Tie-Breaker Rules: Educate clients about how the IRS resolves disputes if custody is evenly split.

Family law attorneys can help clients avoid confusion, missed tax benefits, and potential IRS audits by emphasizing the importance of the majority-of-nights rule. Proper planning and record-keeping are key to navigating these rules successfully.

The U.S. tax code has become a maze of regulations that overwhelms taxpayers and consumes billions of hours annually. The National Taxpayers Union Foundation estimates Americans spend 6.5 billion hours on tax compliance, costing over $280 billion per year. Simplifying the code isn’t just about saving time—it’s about ensuring fairness and restoring trust in the system.

The Challenges of a Complex Tax Code

The tax code’s complexity disproportionately affects those with fewer resources. While the wealthy and corporations can afford accountants to minimize taxes, middle- and low-income taxpayers often struggle. Programs like the Earned Income Tax Credit (EITC), meant to help low-income individuals, are so complicated that millions miss out entirely. Simplification would level the playing field and reduce errors.

Taxable income calculations add further frustration. Determining how much Social Security is taxable involves multi-step formulas comparing adjusted gross income (AGI), nontaxable interest, and half of benefits against thresholds based on filing status. These rules confuse taxpayers and lead to errors. Simplifying such provisions would ease the burden.

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How Simplification Can Be Achieved

• Consolidate Deductions and Credits
  To simplify eligibility and reduce confusion, similar benefits, such as tuition expenses, student loan interest, and education credits, can be combined into one “Education Expense Deduction.”
• Expand Pre-Filled Tax Returns
  The IRS could pre-fill returns for taxpayers with straightforward situations, like W-2 earners, using existing records. Filing would then be as simple as reviewing and submitting.
• Eliminate Corporate Income Taxes
  Corporate taxes are passed on to consumers through higher prices, employees through lower wages, and shareholders through reduced returns. Eliminating them would remove this hidden tax, address the double taxation problem on corporate earnings, and encourage reinvestment in growth and innovation, keeping business investment strong.
• Eliminate Special Capital Gains Tax Rates
  Replace reduced rates for long-term gains with an inflation-adjusted basis for long-term assets. For example, a $10,000 stock bought 20 years ago that has doubled with inflation would have an adjusted basis of $20,000, taxing only real gains. This would ensure fairness while simplifying the system.
• Automate Tax Benefits
  Automatically applying credits like the Child Tax Credit using IRS records would reduce errors and ensure eligible taxpayers don’t miss out.

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A Path Forward

The tax code has grown increasingly complex over time, piling on burdens for taxpayers. The last significant simplification came with the Tax Reform Act of 1986. Now is the time for another overhaul. By consolidating deductions, automating benefits, eliminating corporate taxes, and reforming capital gains taxation, we can save millions of hours and restore simplicity to the system.