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:
- Stock Basis – This starts with the amount you paid for your stock or the property value you contributed to the company.
- 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)
- 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).
- Nondeductible expenses – Some expenses, like penalties and certain meals, reduce basis even though you can’t deduct them.
- 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.
