The “Stock Basis Schedule” of S-Corporations and Why You Should Care.
Has your accountant ever told you what your Basis Schedule is? Has your accountant ever recommended that you take a distribution or a dividend or warned you about taking them? If the answer is no, then you do not have an accountant, you likely only have a tax preparer. That’s because an accountant would explain these things to you during the tax year and a tax preparer would just wait around to file your taxes.
We see many contractors write themselves checks during the year and call it a “Distribution”. At the end of the year, the contractor may be surprised with a higher tax bill than what they expected. That’s because they end up owing for regular payroll taxes and the payout is treated as regular income.
For the shareholder to determine whether the distribution is non-taxable they need to demonstrate they have an adequate stock basis.
The S-Corporation Stock Basis of your investment starts with your initial capital contribution and your initial cost of the stock purchased. Stock Basis is increased by the income you receive and decreased, but not below zero, by any loss, deductions, or distributions on the Form K-1 you receive.
The order in which Stock Basis is increased or decreased is important. Because both the taxability of distribution and the deductibility of a loss is dependent on Stock Basis, there is an ordering rule in computing stock basis. The stock basis is adjusted annually, as of the last day of the S corporation year, in the following order:
1. Increased for income items and excess depletion
2. Decreased for distributions
3. Decreased for non-deductible, non-capital expenses and depletion
4. Decreased for items of loss and deduction
When determining the taxability of a non-dividend distribution, the shareholder looks solely to their Stock Basis (debt basis is not considered).
For loss and deduction items, which exceed a shareholder’s Stock Basis, the shareholder is allowed to deduct the excess up to the shareholder’s basis in loans personally made to the S-Corporation. Debt basis is computed similarly to Stock Basis but there are some differences.
If a shareholder has S-Corporation loss and deduction items in excess of Stock Basis and those losses and deductions are claimed based on a debt basis, the debt basis of the shareholder will be reduced by the claimed losses and deductions.
Note: An S-Corporation is a corporation with a valid “S” election in effect. Distributions always come in the form of cash. In the case of S-Corporations, entities will report these payouts on IRS Form K-1.
Be careful writing yourself a check and thinking that the money will not be treated as regular payroll and income to you. Monitor your Basis and take advantage of any opportunity you have to take a Distribution. Speak to your accountant about how to calculate and monitor your Basis. If they are not sure how to do it or don’t respond to you, it may be time for a real accountant.