What is Basis?
Basis measures the amount that the property’s owner is treated as having invested in the property. In most situations, the basis of an asset is its cost to you. The cost is the amount you pay for the property in cash, debt obligations, and other property or services.
Basis in An S Corporation
In the S corporation context, the basis is the shareholder’s investment in the company. This investment in the company can change as time progresses. The amount of a shareholder’s stock and debt basis in S corporation is especially important. Each year a shareholder’s stock and/or debt basis of an S corporation increases, or decreases based upon the S corporation’s operations.
Calculating the S corporation shareholder’s basis correctly is crucial because it has an impact on the amount the shareholder can withdraw or receive from the S corporation without realizing income or gain. In computing stock basis, the shareholder starts with their initial capital contribution to the S corporation or the initial cost of the stock they purchased. When you contribute funds or other property into an S-Corporation, your basis increases. When you pull income out of your S-Corporation, your basis in the S-Corporation decreases. Often different shareholders in an S-Corporation start with equal basis amounts, but each shareholder’s basis can diverge through the life of the business.
The basis amount is then increased and/or decreased based on the pass-through amounts from the S corporation. An income item will increase stock basis while a loss, deduction, or distribution will decrease stock basis. Another important rule to remember is that a basis can never go negative. Basis adjustments are generally calculated at the end of the corporation’s each taxable year. Updating basis each year can be a straightforward process, however when it is overlooked it can be a challenging task. Common items that increase basis include capital contributions, ordinary income, investment income and gains. And common items that decrease basis include Sec. 179 deductions, charitable contributions, nondeductible expenses, and distributions.
How to Calculate
The order in calculating the basis is also very vital. First, basis is increased by income items; then decreased by distributions; and, finally, decreased by deduction and loss items. The order is critical because, if the basis is positive before distributions but would be negative if all deduction items were subtracted, then the excess loss is suspended rather than the excess distributions being taxable.
Aside from the above, there are two other vital points to know which include the following. An owner’s share of losses that exceed basis are carried over to offset future income or basis. This means that a shareholder is limited to the amount of losses they can utilize in a given year to the extent of the basis that they have in the corporation. And finally, the S corporation shareholders generally do not increase their basis for debts owed by the company to third parties but increase debt basis only for a direct loan they make to the corporation.
In short, we should all stay up to date with tracking our basis annually and we should have an end vision in mind when working through it. It is vital to track the basis from the beginning day one and keep tracking it. And consider saving all Schedules K-1 to the company’s permanent file in case basis needs to be re calculated or reviewed.
If you would like to learn more about basis in an S Corp and how we can help you navigate it, you can fill out our questionnaire to get started.
-Priyank Shukla, CPA, Senior Accountant