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Nicholas
P. DiNatale, CPA - Business Resources - FAQ How is basis computed for an individual who owns the stock of an S-corporation? Is this the calculation that's performed in the "accumulated adjustments account" (M-2) on the corporate tax return? Is this the same amount of money that is "at risk"? To simplify the answer, lets assume the S-corporation has been an S-corporation since inception. If it hasn't, items such as accumulated earnings and profits (AE&P) and previously taxed income (PTI) will affect the basis calculation. If the company has always been an S-corporation, AE&P and PTI will not exist. Calculating basis is a rather complicated matter. It sounds easy from the outside, but many factors come into play. There are also two types of basis: stock and debt. Lets begin with stock basis. Depending on the way stock was acquired, the basis amount could be one of a number of amounts. Most stockholders acquire their S-corp stock by capitalizing the company with cash and/or equipment contributed to the company upon inception. If this is the case, the stock starts off with a basis equal to the cash paid in and/or the contributor's basis in the property or equipment given to the corporation in exchange for the stock. If equipment transferred to the company had leins against it, this will reduce basis as will the fair market value of assets taken back by the stockholder. Also, any gain realized on the transfer will increase basis. Some of the other ways stock could be acquired are:
Once initial stock basis is established, the shareholder then adjusts this basis annually based on items reported on schedule K and passing through on form K-1. Initial stock basis is increased or decreased by tax basis passthrough income, distributions, and various loss and deduction items. These are the same items that are recorded on schedule M-2 as changes to AAA. Multiple shareholders will use their allocation of these items as reported on form K-1. Preparing schedule M-2 is a tax lesson in itself and is covered in sufficient detail in the form 1120S S-corporation tax return instructions and can be downloaded from the IRS website (www.irs.ustreas.gov). Debt basis is the stockholder's basis in loan advances made to the corporation. Once accumulated losses have reduced stock basis to zero, the basis in the debt to the stockholder can then be used to further deduct losses. The purpose of this is to provide a tax incentive encouraging cash advances of operating capital to the company during difficult times. Once stock and debt basis have been reduced to zero the stockholder has hit her "at risk" limit. Shareholders cannot deduct S-corp losses in excess of overall basis. Such losses will tracked by the stockholder and reported on their personal tax return on form 6198 and carried forward to future years when a net income is allocated to the shareholder on form K-1. Once the corporation starts to become profitable, basis is restored in reverse order: debt first, stock second. Debt which has a zero basis due to deducted losses cannot be repaid to the stockholder. If so, a tax will result. Do not confuse the stockholder's basis calculation with the accumulated adjustments account (AAA) on schedule M-2. AAA is a corporate level account and basis is calculated at the shareholder level. Generally, stock basis and AAA are the same, but due to various issues that may occur (debt basis, suspended losses, basis of contributed property, etc) AAA and overall stockholder basis will differ. AAA is basically tax basis retained earnings and will often differ from balance sheet retained earnings since the latter is calculated on book basis transactions. Remember, this advice is general as I do not know the nature, history or other details occurring with your particular situation. If you need more personalized advice, let me suggest a meeting at your convenience where we could discuss your company in more detail.
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