This is one of the clearest explanations I know of from the IRS. The stock basis is calculated as follows:
In computing stock basis, the shareholder starts with their initial capital contribution to the S corporation or the initial cost of the stock they purchased (the same as a C corporation). That amount is then increased and/or decreased based on the flow-through amounts from the S corporation. An income item will increase stock basis while a loss, deduction, or distribution will decrease stock basis.
A shareholder's stock is increased by:
1.) Ordinary Income (K-1 Line 1)
2.) Separately State Items (K-1 Lines 2-10)
3.) Tax exempt income (K-1 lines 16A and 16B)
4.) Excess depletion (K-1 Line 15C)
A stockholders basis is decreases by:
1.) Ordinary Loss (K-1 Box 1)
2.) Separately stated items (K-1 boxes 2-12O, 14L, 14M)
3.) Nondeductible expenses (K-1 box 16C)
4.) Nondividend distributions (K-1 box 16D)
5.) Depletion (K-1 Box 17R)
This needs to include all years.
NOTE: Only non-dividend distributions reduces stock basis, dividend distributions do not. The corporation is responsible for telling the shareholder the amount of non-dividend and dividend distributions. Box 16D of Schedule K-1 reflects non-dividend distributions. Form 1099-DIV is used to report dividend distributions; dividends are not reported on the shareholder's Schedule K-1.
Most distributions from an S corporation are non-dividend distributions. Dividend distributions can occur in a company that was previously a C corporation or acquired C corporation attributes in a non-taxable transaction (i.e., merger, reorganization, QSub election, etc.).
The order in which stock basis is increased or decreased is important. Because both the taxability of a distribution and the deductibility of a loss are dependent on stock basis, there is an ordering rule in computing stock basis. Stock basis is adjusted annually, as of the last day of the S corporation year, in the following order:
- Increased for income items and excess depletion;
- Decreased for distributions;
- Decreased for non-deductible, non-capital expenses and depletion; and
- Decreased for items of loss and deduction.
When determining the taxability of a non-dividend distribution, the shareholder looks solely to his/her 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 debt basis, the debt basis of the shareholder will be reduced by the claimed losses and deductions.
If an S corporation repays reduced basis debt to the shareholder, part or all of the repayment is taxable to the shareholder.
