Why (and How) S Corporation Investors Should Calculate Their Basis Annually

The basis, or net investment, in a shareholder’s S Corporation stock begins the day the shareholder purchases stock and continually changes throughout the year based on the company’s operations. Such constant activity creates the need for shareholders to recalculate their basis annually to help ensure appropriate tax reporting on their individual returns.
 
Here are a few reasons why: 

• If the distributions or losses from an S Corporation exceed the shareholder's basis, the distributions may be taxable or losses may not be deductible.
• An accurate basis calculation will help determine the amount of gain or loss on disposition of the stock.
• The basis may be different for regular tax purposes versus what is used for the alternative minimum tax (AMT) calculation.

While the S Corporation is technically responsible for tracking shareholder basis, it does not have to provide that information to shareholders — and generally doesn’t unless their accountant also prepares the shareholders’ returns. Therefore, shareholders need to either proactively request the information each year from the S Corporation or calculate their basis themselves.
 
An often overlooked task for many, as the number isn’t as critical when a company is profitable and making minimal distributions, keeping up on the calculations each year will help shareholders avoid a costly and cumbersome project of collecting and sorting through multi-year documents when an event occurs that makes the basis calculation more meaningful (such as a change in the shareholder’s ownership, disposition of the stock or significant company losses). 

The Basis Calculation

Many individuals prefer to do the calculation themselves. If you’re up to the task, you must calculate your basis according to the Internal Revenue Code’s specific order (absent additional elections that may be available). In fact, the specific rules for this calculation are another reason calculating the number can be burdensome if not maintained on a yearly basis.
 
Basis in S Corporation stock starts with the amount the owner paid for the stock. Then you must follow ordered steps to adjust that basis every year:

1. Increased for income items and excess depletion;
2. Decreased for distributions;
3. Decreased for non-deductible, non-capital expenses and depletion; and
4. Decreased for items of loss and deduction. 

An important note: The recently passed Tax Cuts and Jobs Act (TCJA) allows for a 20% deduction of small business income for flow-through entities. If the shareholder qualifies for a reduction of income on their tax return, this reduction will have no effect on the calculation of the shareholder's basis in the S Corporation.
 
Shareholders of S Corporation stock also need to maintain their debt basis in the S Corporation. Debt basis is limited to loans that the shareholder has personally made to the corporation. Unlike with partnerships, debt basis does not include loans from outside parties, even if the shareholder has guaranteed the loan.
 
Regardless if you, as a shareholder, or the S Corporation in which you invest make the basis calculation, be sure to have the information in your records each year to accurately reflect on your tax returns now and in the future.
 
Contact Mike McGivney or a member of your service team to discuss this topic further.

Cohen & Co is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law with your professional advisers.