Loan BasisShareholder may advance money to the S-Corporation as a loan. A common example is a shareholder that pays for company expenses using his personal credit card, and submits an expense report to the company for repayment. Loans to the company may be short-term loans (to be repaid in one year or less) or long-term loans (to be repaid in more than one year). Shareholder's making loans to their S-Corporation may take a tax deduction in the current year for losses in excess of their stock basis, but only to the extent they have loan basis.
Loan basis, and adjusted loan basis, is calculated as follows:
- Initial amount loaned to the company
- + Additional amounts loaned to the company
- + Deferred interest that is capitalized (added to the loan) instead being repaid
- - Amount of loan principal repaid
- - Amount of loan principal forgiven by the shareholder
- - Amount of loan principal converted to stock
- - Share of net loss in excess of shareholder's adjusted stock basis
- = Adjusted basis in S-Corporation debt at the end of the year.
Negative Basis and Suspended LossesAdjusted basis cannot be below zero. However, using the formula above for calculating adjusted basis will often result in a negative number. Here are the rules for handling "negative basis" of S-Corporation stock:
- Shareholder's stock basis is reduced, but not below zero,
- Then Shareholder's loan basis is reduced, but not below zero.
Any excess "negative basis" is treated as a non-deductible loss. This excess loss is a "suspended loss" and carries over to future years indefinitely. The suspended loss may be deducted in any future tax year during which the shareholder has restored her loan basis or stock basis.
If the shareholder had both an equity investment and advanced a loan to the company, then in following years the shareholder must restore her loan basis before restoring her stock basis.
Restoring BasisShareholders may restore their stock basis or loan basis in several ways. The easiest way to restore basis is to make additional cash investments (to restore stock basis) or to advance additional cash loans (to restore loan basis).
Adjusted stock basis and loan basis should be calculated tentatively just before the end of the year. This will give shareholders sufficient time to make additional loans or equity investments to ensure that any losses are fully tax-deductible.
At-Risk RulesEach shareholder has an amount at risk. This is the amount of money the shareholder stands to lose from her investments or loans to the company. A shareholder's amount at risk is calculated as follows:
- Adjusted Stock Basis
- + Adjusted Loan Basis
- = Amount At Risk.
Any loss in excess of the amount at risk is a "suspended loss" and follows the rules for suspended losses outlined above.
Each shareholder's stock basis and loan basis will be adjusted for her pro-rata share of losses even if those losses are suspended because of the at-risk rules. It is therefore very important for the S-Corporation and its shareholders to track adjusted stock basis and adjusted loan basis accurately and meticulously.
Passive Activity LossesS-Corporation shareholders are subject to the passive activity rules. These rules govern to what extent an S-Corporation loss is currently deductible by a shareholder.
If the S-Corporation is engaged in the rental property business, then shareholders must meet the stringent "active participation" tests for real estate professionals in order to deduct rental losses in full. If a shareholder cannot meet the active participation tests for real estate professionals, then S-Corporation rental losses are deductible only to the extent the shareholder has passive activity income.
If the S-Corporation is engaged in any business but the shareholder does not actively participate in the S-Corporation's business, then S-Corporation losses are deductible only to the extent the shareholder has passive activity income.
Passive activity income includes passive income from S-Corporations, partnerships, trusts, interest, dividends, and other investment income.