REG CPA Practice Questions Explained: How to Calculate S Corp Shareholder Debt Basis

How to Calculate S Corp Shareholder Debt Basis

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In this video, we walk through 5 REG practice questions teaching how to calculate S Corp shareholder debt basis and stock basis. These questions are from REG content area 5 on the AICPA CPA exam blueprints: Federal Taxation of Entities.

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Overview of S Corporation Shareholder Debt Basis and Stock Basis

An S corporation shareholder’s basis can be broken down into two main components: stock basis and debt basis. Each type of basis has different implications for tax reporting and affects the shareholder’s financial relationship with the corporation. Understanding how these bases are calculated, adjusted, and utilized is crucial for S corporation shareholders to navigate tax obligations efficiently.

Stock Basis

The stock basis of an S corporation shareholder starts with the initial investment in the corporation’s stock (capital contribution) or the cost of acquiring the stock. It is then adjusted annually based on the shareholder’s proportional share of the corporation’s income, losses, deductions, and credits. Here’s how the stock basis is increased and decreased:

  • Increases:
    • Contributions of additional capital.
    • Share of the corporation’s income, including tax-exempt income.
  • Decreases:
    • Distributions to the shareholder that are not dividends (reducing capital).
    • Share of corporate losses and deductions.
    • Non-deductible corporate expenses such as fines or penalties.

Example of Calculating Stock Basis:

  • Marianne purchases shares in ABC Corp, an S corporation, investing $15,000 initially.

Transactions During the Year:

  • Marianne’s share of ABC Corp’s net income: $5,000.
  • Marianne receives a distribution of $4,000.

Stock Basis Calculation:

  1. Initial Stock Basis: $15,000 (initial investment)
  2. Increase from Income: +$5,000 (share of net income)
  3. Decrease from Distribution: -$4,000 (cash distribution)

End of Year Stock Basis = $15,000 + $5,000 − $4,000 = $16,000

Debt Basis

The debt basis is separate from the stock basis and tracks the amount of money loaned by the shareholder to the corporation. Unlike the stock basis, debt basis is affected by direct debt transactions between the shareholder and the corporation:

  • Increases:
    • Additional loans made by the shareholder to the corporation.
  • Decreases:
    • Repayment of loans by the corporation to the shareholder.

It’s important to note that a shareholder’s debt basis can only be used to deduct losses if the stock basis has been exhausted.

Example of Calculating Debt Basis

  • Marianne loans $10,000 to ABC Corp at the beginning of the year.

Transactions During the Year:

  • ABC Corp repays $3,000 of the principal on the loan to Marianne.

Debt Basis Calculation:

  1. Initial Debt Basis: $10,000 (amount of the loan)
  2. Decrease from Repayment: -$3,000 (principal repayment)

End of Year Debt Basis = $10,000 − $3,000 = $7,000

Tax Basis (Combined Stock and Debt Basis)

The tax basis is the sum of both stock and debt bases. It’s crucial for determining the overall ability of the shareholder to absorb losses from the S corporation and for other tax implications. The tax basis directly impacts what happens when the corporation makes distributions:

  • Distributions and Their Effects:
    • If distributions during the year are less than the combined stock and debt basis, they are typically tax-free up to the amount of accumulated adjustments account (AAA).
    • Distributions that exceed the stock basis but not the combined tax basis (stock + debt) reduce the debt basis.
    • If distributions exceed the combined tax basis, the excess is taxed as a capital gain, reflecting a return of capital that exceeds the shareholder’s total investment in the corporation.

Impact of Distributions Exceeding Tax Basis

When distributions exceed a shareholder’s total tax basis, it indicates that the shareholder is receiving back more than what was initially invested or accumulated through operations. This scenario generally results in capital gains taxation, with the distribution amounts exceeding the tax basis treated as gains from the sale of the stock.

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