S Corporation Basis & Distributions - Oelerich & Associates · 2017-09-20 · I. Shareholder Stock Basis. E. Basis can come from and records should be maintained of: 1. Purchase of

What’s New

12 - S-Corporation Basis & Distribution 1

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I. Shareholder Stock Basis

By including the tracking of basis subject to your engagement letter later issues can be resolved


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Type Text HereLikely a tool available

in your tax software but you have to turn it on


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E. Basis can come from and records should be maintained of:

1. Purchase of shares – Records of amount paid for same

2. Basis as part of a IRC 351 exchange – Worksheet showing Net Basis of Assets less Liabilities Exchanged

3. No basis will come from retained earnings during time as C-Corp

4. For stock received by gift the lesser of donor’s basis or FMV at time of gift


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Basis issues can be easily overlooked until the IRS decides to examine the entity. To reconstruct basis means

going back to day one. Action Item – Prepare the

worksheet ASAP based on best estimates to go forward. IRS is normally happy with three years.


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II. Annual Basis Adjustments(Reg. 1.1367-1)

B. There are specific steps in making the calculation for Stock Basis

1. Increase with the positives

2. Reduce for distributions

3. Decrease by the negatives


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II. Annual Basis Adjustments(Reg. 1.1367-1)

There is no such thing as less than ZERO


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III. Order and Timingof Basis Adjustments

D. For purposes of gain/loss on the sale of the shareholders stock adjustments are made prior to disposition – Example

Sale Date June 30 – 50% shareholder TommyBasis on Sale Date $10,000S-Corp Net Profit Reported on Schedule E - OrdinaryBasis Adjusted for “Pre-sale Activity”Sale Price 06/30Gain reported on Schedule D - Capital

$100,000 $25,000$35,000$40,000$5,000


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Chapter 12: S Corporations Basis and Distributions

Abe – Example – Basis Ordering1. Beginning Basis $13,0002. Income $03. Non-Deductible Expenses -$3,5004. Remaining Basis $9,5005. Non-Separately Stated Loss -$14,0006. Suspended Loss $4,500

Deductible Loss -$9,50012 - S-Corporation Basis & Distribution 15

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The Example ended with $4,500 of suspended losses due to elimination of basis for non-deductibles, however an election can be made under Reg. 1.1367-1(g) HOWEVER this election is made at the shareholder level and attached to the shareholder’s 1040


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The outcome with an ordering election – ExampleAbe – He has made the ordering Election1. Beginning Basis $13,0002. Income $03. Remaining Basis $13,0004. Non-separately Stated Loss -$14,0005. Deductible Loss $13,0006. Suspended Loss $1,0007. Non-deductibles CarriedForward to following year $3,500


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The GOOD about the election – Non-Deductible Losses will be applied after Deductible Losses

The BAD about the election Absent an election if there is insufficient basis to cover non-deductibles they are gone foreverWhen the election is made those non-deductible losses will follow the taxpayer FOREVER


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IV. Adjusting Basisfor Pass-Through Distributions

$85,500 $30,500

$29,900

$600


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2017


A word of warning - Darned if you do and darned if you do not: KEEP THOSE BASIS RECORDS CORRECTLY


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A word of warning – Losses on property distributed to S/H are not deductible

Remember - Unrecognized losses may affect basis on later sale.


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V. Deducting Shareholder Lossesto the Extent of Basis

If losses exceed basis then the allowed losses are allocated in proportion to the basis:


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V. Deducting Shareholder Lossesto the Extent of Basis

% of total allowed


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VI. Bona Fide Debtis now the Standard

IRS accepted proposed regulation 1.1366-2 and 1.1366-5 substantially as proposed.

Adoption Date – 07/23/2014 –includes any tax year which includes adoption date.

Statement of regulations –General tax principles determine whether debt is “bona fide”.


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What this all means.

B. There is no longer any requirement to satisfy the “actual economic outlay” doctrine.

C. A reaffirmation that acting as a guarantor does not create or increase basis.

E. IRS is seeking to clarify the status of S corporation debt between the shareholder and corporation to reduce court cases.


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There are five examples in the text on Pages 233 & 234


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VII. Important and Interesting Court Cases Regarding Debt Basis

1. Sleiman v. Comm. (CA 11 1999) - The beginning of the discussion, no basis from a guarantee. Bank considered guarantee as a protection from future liability of site contamination.

2. Selfe v. US 57 AFTR 2d 86-464 –Determination of who really was the debtor, court determined that taxpayer not corporation was actually the borrower.


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B. James Maquire et ux vs Comm. TC Memo 2012-160 – The challenge of the economic change standard promulgated by IRS. Court applied test as to whether the taxpayer ability to take a distribution was affected.

C. Hargis, TC Memo 2016-232 – Question as to who had economically been changed by the loan. The court was not persuaded by the taxpayer being listed as co-borrower and/or guarantor of loans:


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The lender intended to make a loan to the taxpayer, however the loan documents indicated the taxpayer’s S Corp is the

borrower. The taxpayer used the loan for basis to deduct losses. In the case the Court

sided with:A. The taxpayer- thanks to the testimony of

Bank’s lending officer.B. With IRS, because the Court found there was

insufficient evidence to find the loan was made to taxpayer.

Banks Case



1. In Banks none of the loans increased the basis of the shareholder

2. All transactional activity of the loans was directed through the corporation.

3. In spite of Arkansas law not seeing a difference as a co-borrower and/or guarantee, the court citing two prior decisions cast the shareholder as having “bare potential liability”.

4. In the final analysis the court said “show me the money”.


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E. Phillips, TC Memo 2017-61 – Are judgements an economic outlay?

The court found for the IRS and did not allow the taxpayer basis for the judgements entered in that no “economic outlay” was ever made.


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Loans• Shareholder loans funds to corporation

Dist Net Losses

• Losses can reduce basis of loan to ZERO

Dist Net Income

• Income restores basis of loans to the extent of net income

Suspended Losses

• Suspended losses to the extent of loan basis restored by profits are allowed

Loan Repayments

• Loan repayments in excess of adjusted loan basis are taxable

VIII. Deducting Shareholder LossesAgainst Debt Basis


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The Process – When the shareholder “consumes” their stock basis they are able to use basis to the extent of direct loans

In our example using a combination of $25,000 of stock basis and $50,000 of loan basis the

shareholder is able to deduct the entire loss

Example - Gary Stock Basis Loan Basis

Basis $25,000 $50,000Pass through Gains $5,000Pass through Losses -$47,000Excess Loss -$17,000Basis at Year End $0 $33,000


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The mechanics: Balance sheet amounts-Loan from shareholders are not adjusted for basis applied to losses.

C. Any future pass through income will first restore loan basis to the “balance” of the loan –

What does our tax software know about the loan?


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D. Loans will be restored only to the extent of their face amounts – once the loan is restored any additional amounts will be applied to stock basis

If the net income i.e. ALL pass-thru income less non-dividend distributions less losses and deductions is not large enough to completely restore the loan basis no allocations are made to stock basis and distributions are not taxable – See Example


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Page 239VIII. Deducting Shareholder LossesAgainst Debt Basis



Look at the math per the ordering rulesExample - Gary Stock LoansBasis $0 $33,000Non-Sep. Inc. $41,000LT Cap. Gain $5,000Basis before Deductions $46,000Distributions -$30,000Sec 1231 Loss $-6,000Net Increase $0 $10,000Ending Basis $0 $43,000


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Only one way to restore loan basis – MAKE MONEY


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F. What if the net is a loss?1. Stock basis is increased by any income or

gain items.2. Stock basis is reduced by loss and deduction

items.3. Once stock basis is reduced to zero any

remaining loss items will be applied to debt basis


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Look at the math per the ordering rulesExample Stock LoansBasis $0 $33,000Non-Sep. Inc. $41,000LT Cap. Gain $5,000Basis before Deductions $46,000Distributions -$48,000Excess Taxable Dist. LTG $2,000Sec 1231 Loss $-6,000Loss Applied to Debt BasisEnding Basis $0

-$6,000$27,000


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H. If stock and/or debt is disposed prior to year end then adjustments are made at the time of the disposition


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Example - Paul Stock LoansBasis $0 $33,000Net Income (Positive Adj.) $40,000Basis before Distributions $40,000Distributions $30,000Net Positive Adj. Applied to LoanLoan Basis after Adj.Loan RepaymentsGain on Loan Repayment Ending Basis $0

$10,000$43,000$50,000$7,000


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Year end adjustments are only one way

I. If more than one debt at year end apply reduction in proportion to basis of all debts.

J. If the stock is disposed of during the year the adjustments are made just prior to the disposition.


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N. Distributions DO NOT reduce debt basis.

A payment to the shareholder is either a:

Distribution

Debt Payment


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Q. Open Account Debt – Regulation 1.1367-2(a)(2)

1. Not evidenced by separate notes AND does not exceed $25,000 at close of year.

2. Advance and payments treated as single transaction.

4. EXCEPTION – When the balance exceeds $25,000 at year end then note is treated as other than an open account note.


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Effect of the regulationsWhen the balance at year end exceeds $25,000 then each advance for that tax year and ALL subsequent years will be treated as a separate written note Outcome – Each note repayment will be proportional to the indebtedness of all notes


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IX. Repayment of Reduced-BasisShareholder Debt

A. Loan repayments to a shareholder are required to be reported on the shareholder’s K-1 and the

1120S.

This requirement is for ALL repayments not solely taxable repayments


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B. Nature of loan repayment income:

1. If a written loan if taxable income then gain is capital in nature.

3. Holding period will dictate the nature of the capital gain LT or ST


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C. “Distributions” do not reduce debt basis

If the payment is a distribution, if the distribution is taxable will be dependent on stock basis

If the payment is a repayment of the loan then taxability will be dependent on the loan basis.

Choose wisely – perhaps an opportunity for capital income at a ZERO federal rate


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Remember to complete Line 9

Schedule B – First Appeared in 2007

XIII. Earnings & Profits

Example:E&P using tax basis $15,000Required AdjustmentsIRC 179 $100,000

Allowed Depr $ 60,000Excess Depr $40,000

Adjusted AE&P $55,000

XIII. Earnings & Profits


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55,000

XII. Earnings & Profits


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XV. Other Adjustments AccountA. Contains tax exempt income1. Like AAA, OOA distributions are tax free

to the extent of basis BUT

2. Last in line and if you got AE&P difficult to get to

B. Revenue Ruling 2008-42 held that not only does tax free income go to AAA so do the expenses that creates this income, i.e. life insurance premiums


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XV. Distributions


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XV. Distributions


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XVIII. Elections to Distribute E&PBefore AAA

A. Elections Available

1. By-pass AAA

2. By-pass PTI

3. No money, just pretend (book entry and issue 1099-DIV.

If a taxpayer has exposure to IRC 1411 E&P dividends will not be exempt from like other S distributions/earnings


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Why?

Get rid of E&P left over from “C” days

Preserve S election if too much passive income

Take advantage of a personal NOL

Take advantage of the 15%/0% tax while it’s still hereReduce future exposure to IRC 1411

and/or 20% LTCG


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• How?Attach a statement to the returnDon’t actually have to pay the cash – can be a deemed (pretend) distribution


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The Deemed (Pretend) Dividend

Coverts Earned Capital to Contributed Capital

Don’t actually have to pay the cash – can be a deemed (pretend) distribution


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XVI. Elections to Distribute E&PBefore AAA


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XVII. Elections to Distribute E&PBefore AAA

No Dist Deemed Distribution

Ordinary Inc $65,000 $65,000K-1 Ord. Loss –No Basis $ 0 -$25,000Qual. Div. $ 0 $25,000AGI $65,000 $65,000Ded./Exemp. $19,800 $19,800Taxable Inc. $45,200 $45,200Tax $5,888 $2,138Federal Tax Savings $3,750


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XIX. Redemptions and AAA

• If S-Corp redeems shareholder, how taxed?

• Not entirely a capital gains loss transaction: There’s AAA!

• 1st : allocate portion of what’s paid to AAA

• 2nd : Balance, goes to capital stock – Any amounts over basis will be capital gain


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S Corporation Basis & Distributions - Oelerich & Associates · 2017-09-20 · I. Shareholder Stock Basis. E. Basis can come from and records should be maintained of: 1. Purchase of