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Friday, February 3, 2012
The basics of S corporation stock basis
Avoid problems in calculating and tracking shareholders' basis.
BY MEREDITH A. MENDEN, CPA
The concept of basis is simple, but calculating basis for S corporation stock takes much of many CPA tax practitioners’ time and energy. Why is this the case?
Basis measures the amount that the property’s owner is treated as having invested in the property. At the start of the investment, this is the property’s cost. But in the S corporation context, basis can become a moving target as a shareholder’s investment in the company changes. Unlike with C corporation stock basis, which stays the same each year, annual income, distributions and loans can all affect an S corporation shareholder’s basis, in sometimes surprising ways.
Calculating the S corporation shareholder’s basis correctly is important because it measures the amount the shareholder can withdraw or receive from the S corporation without realizing income or gain. The shareholder’s basis should reflect the shareholder’s economic investment in the corporation. Basis adjustments should be made at the end of each taxable year, taking into account income, distributions and deductions and losses—in the right order.
Often, the task of tracking basis is neglected because, when a profitable company makes only minimal distributions, the number simply doesn’t matter—until a major change happens, such as a change in the shareholder’s ownership or the end of the company’s life. When individuals embark on an investment or business venture, they often don’t think about what happens when the venture is over. Unless the tax accountant preparing the shareholder or company tax returns has the foresight to begin and maintain the basis calculations, piecing stock basis back together is like reconstructing a mosaic without all the pieces—it’s tedious, often difficult and sometimes nearly impossible. CPAs can help their shareholder clients avoid this mess by tracking basis from day one or as soon as they realize that their clients’ basis records are lax.