The Importance of Tracking S Corporation Basis to Deduct Losses

2/18/2010

By Mark Corey, CPA

Due to the poor economy over the last several years, many businesses are experiencing losses, sometimes for consecutive years. S corporation shareholders face a special burden regarding their loss calculations. In order to deduct the pass through S corporation losses, these entities are required to calculate the basis in their S corporation stock per Internal Revenue Code section 1366(d). Often, your tax preparer will prepare a basis schedule showing all changes to your S corporation basis, but ultimately, it is the S corporation shareholder’s responsibility to make sure they have accurately tracked their basis in order to deduct any current losses.

The fundamental rules for tracking basis are contained in Internal Revenue Code section 1367 and they provide the following basic rules:

Increases in Basis

• The items of income described in subparagraph (A) of section 1366 (a)(1)
• Any non-separately computed income determined under subparagraph (B) of section 1366 (a)(1)
• The excess of the deductions for depletion over the basis of the property subject to depletion.

Decreases in Basis

• Distributions by the corporation which were not includible in the income of the shareholder by reason of section 1368
• The items of loss and deduction described in subparagraph (A) of section 1366 (a)(1)
• Any non-separately computed loss determined under subparagraph (B) of section 1366 (a)(1)
• Any expense of the corporation not deductible in computing its taxable income and not properly chargeable to capital account
• The amount of the shareholder’s deduction for depletion for any oil and gas property held by the S corporation to the extent such deduction does not exceed the proportionate share of the adjusted basis of such property allocated to such shareholder under section 613A (c)(11)(B).

These are the central rules for determining S corporation stock basis, but there are complicated rules related to transactions that fall outside these rules. Also, in order to make the deduction of S corporation losses more complicated, there are at-risk limitations under section 465, and passive activity loss limitations under section 469 to consider. If you are in a position of deducting losses from your S corporation, you should consult with your tax advisor on your S corporation basis calculations.