S corporations are popular for many good reasons. One of them is the ability to deduct corporate losses on the owners' 1040s. It's been a rough year for a lot of folks and many taxpayers are looking forward to a nice tax refund from their 2009 business losses. If you are one of them, make sure you don't lose your loss deduction for lack of basis in your S corporation; shareholders can only deduct losses to the extent of their basis.
A taxpayer's initial basis in an S corporation is the amount paid for the stock. It is increased by capital contributions and by undistributed income of the S corporation. It is reduced by distributions of S corporation earnings and by S corporation losses.
A shareholder can also deduct losses of an S corporation to the extent
of loans to the S corporation. The loans have to be loans made by the taxpayer; guarantees of debt do not work.
EXAMPLE: Wally starts an S corporation. He contributes $10,000 to
the corporation in exchange for 100% of its stock. The corporation
borrows $5,000 from Wally and $50,000 from the bank, guaranteed by
Wally. The S corporation loses $20,000 in its first year. Wally can
deduct $15,000 of losses this year, based on his $10,000 cash
contribution and his $5,000 personal loan. The guarantee from the bank
does nothing to enable Wally to deduct losses.
LESSON: Wally could have borrowed the bank loan personally and
loaned it to the company; this "back-to-back" loan would have given him
enough basis to deduct the remaining $5,000 S corporation loss.
Taxpayers need to be careful in dealing with S corporation basis. A few points to keep in mind:
- The basis is determined on the last day of the S corporation's tax
year. This means that the taxpayer needs to project taxable income
before year end to determine whether additional loans or capital
contributions to the corporation are called for.
- Taxpayers also need to pay careful attention to how year-end basis contributions are structured. If a shareholder borrows money from one S corporation and loans it to the money-losing corporation to get basis, the money-losing corporation shouldn't send the money right back where it came from; the IRS will disregard all of the transfers.
Basis is only one hurdle S corporation shareholders need to clear before they can deduct losses. Taxpayers also need to be "at-risk" for their basis and the losses can't be "passive" under the "passive activity" rules. It's time to project your year end income and visit your tax pro to make sure you can deduct those 2009 tax losses.
This post originally appeared at IowaBiz.com. It is part of the Tax Update’s series of 2009 year-end planning tax tips.
Tags: basis, iowabiz.com, S corporations, year-end tax planning
Joe Kristan writes the Tax Update items, and any opinions expressed or implied are not necessarily shared by anyone else at Roth & Company, P.C. Address questions or comments on Tax Updates to
But if you’ve got capital loss carryforwards (as many S corp owners do this year), isn’t this a year to take distributions without basis? Wouldn’t they be taxed as capital gains? Essentially tax-free!
Jeff- that’s true, but it’s a different issue. Generating capital gain on distributions can be fine, but it doesn’t help somebody who wants to deduct ordinary S corporation losses.
Also, if you deduct a loss from an S corporation you now have to attach the shareholder basis worksheet and disclose debt the corporation owes you. This will confirm you have both the basis and at risk limits available to deduct the loss.
From the 2009 Schedule E instructions: