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How to Calculate S Corporation Tax Basis and Why Matters

S corporation tax basis and why it matters

At its core, “basis” of any type represents an economic investment. You can measure the basis you have in:

  • Assets
  • Debt
  • An entity
  • Shares of stock

What Is Tax Basis?

The tax basis definition we are talking about with S corporations is the amount of economic investment a shareholder has in their S corporation shares for tax purposes.

Why Is S Corporation Tax Basis Important?

S corporation shareholders must know the basis they have in their stock so they can report their business activity correctly on their tax return. The tax consequences of certain actions will change depending on if the taxpayer has sufficient tax basis. Basis is especially important to know in the following three scenarios:

  1. The S corporation reports a loss. If the shareholder is allocated a taxable loss from the business, that loss is deductible, but only up to their tax basis. If their tax basis cannot absorb the entire loss, some of their loss will not be deductible. That nondeductible loss can be carried forward, but the taxpayer can only deduct that loss when they increase their tax basis.
  2. The shareholder sells some or all their shares of S corporation stock. When disposing of their stock shares, the S corporation shareholder will need to know the basis they have in their stock so they can calculate their gain or loss.
  3. The S corporation makes a non-dividend distribution to the shareholder. Dividend distributions don’t affect shareholder basis, but non-dividend distributions will because they are considered a return of capital.

How Do You Calculate Your Tax Basis in an S Corporation?

Your initial tax basis in an S corporation is what you paid or contributed to acquire your stock shares.

  • If you paid cash, your starting tax basis would be the cash amount you paid for those shares.
  • If you contributed property in exchange for S corporation shares, your starting tax basis would be the fair market value of that property, less any related debt the company assumed.
  • If you inherited the stock your starting tax basis would be the value of those shares at the time of the previous owner’s death.

From there, a shareholder’s tax basis is adjusted up or down for taxable changes to their investment. Here is a simple calculation you can use to determine your tax basis. Adjustments must be made in this order:

Starting Tax Basis

Capital contributions you made to the corporation
+Purchases of additional shares of stock
+Income reported on Schedule K-1 (e.g., ordinary income, capital gains, tax-exempt income)
+Excess depletion
Distributions of capital (not including dividends)
Nondeductible expenses
Depletion
Losses reported on Schedule K-1 (e.g., ordinary losses, short-term investment losses, capital losses)
Deductions (e.g., Section 179 expensing)

Ending Tax Basis

To understand what this basis calculation looks like in practice, let’s walk through a simple example:

You purchased your S corporation shares for $20,000. In Year 1, the S corporation allocated $5,000 in ordinary income and $500 in capital loss to you. Because the entity was short on cash, you contributed $2,000 to boost cash reserves. This was structured as a capital investment rather than a shareholder loan. At the end of the year, your tax basis in your S corporation shares would be $26,500.

Beginning Tax Basis Year 1$20,000
Plus: Capital Contributions$2,000
Plus: Ordinary Income$5,000
Less: Capital Loss($500)
Ending Tax Basis Year 1$26,500

Ordering of Tax Basis Adjustments

Ordering of tax basis adjustments is important because the tax implications will change if your tax basis is zero. When your tax basis is zero, you may not be able to deduct a loss that’s allocated to you, or you may be taxed on a distribution. Let’s continue from the previous example:

You enter Year 2 with a stock basis of $26,500. This year, the S corporation instead allocated a $20,000 ordinary loss to you. During the year, you also received non-dividend distributions of $8,000. At the end of Year 2, your tax basis will have been reduced to zero, and you would have a suspended loss carryforward of $1,500.

Beginning Tax Basis Year 2$26,500
Less: Non-Dividend Distributions($8,000)You have enough basis to absorb the non-dividend distribution, so you will not be taxed on the distribution. It will simply be considered a return of capital.
Subtotal Stock Basis$18,500
Less: Ordinary Loss($18,500)Your loss deduction is limited to tax basis. Even though your loss was $20,000, you can only deduct $18,500. This reduces your tax basis down to zero.
End Tax Basis Year 2$0
Total Ordinary Loss in Year 2$20,000
Deductible Loss($18,500)
Suspended Loss Carryforward$1,500You can carry this loss into Year 3.

Treatment of Suspended Losses

Suspended losses can be carried forward to the next year. The character of the suspended loss will remain the same and will be added to next year’s tax items. So, in the example above, that $1,500 suspended loss could be added to the next year’s loss items to determine whether the activity in Year 3 has any adverse tax effects.

You enter Year 3 with a stock basis of $0 and a suspended loss carryforward of $1,500. This year, the S corporation allocated  a $5,000 ordinary income and a $1,000 capital loss to you. Additionally, you contributed an asset worth $3,000 to the business. At the end of Year 3, you would have a tax basis of $5,500.

Beginning Tax Basis Year 3$0
Plus: Capital Contributions$3,000
Plus: Ordinary Income$5,000
Subtotal Stock Basis$8,000
Less: Capital Loss($1,000) Fully deductible
Less: Suspended Loss from Year 2($1,500)
Ending Tax Basis Year 3$5,500

Tax Planning Using S Corporation Tax Basis

It is the shareholder’s responsibility to know their basis; S corporations are not required to track or report basis for each taxpayer. Because basis calculations can get complex, most shareholders enlist help from their CPAs to keep track of their tax basis. If the S corporation tax basis is kept up to date each year, taxpayers and their accountants can use that information to make even better strategic decisions.

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