Negative basis in k-1 but now have current income

[JulieThu]

Do I have to pay tax on income of schedule K-1 This year while I have negative basis carry forward. 

[LudwigVan_fan]

Several things to consider.  If you had/have a negative basis, that infers either losses from the flow-through in the past, and/or capital withdrawals.   Do you have suspended losses due to basis issues?  Or, is the negative basis due to withdrawals etc.?

In either event, you have to report the current years income.  The difference is that if you have suspended losses due to basis issues, they can be deducted up to the amount of basis increased by current income.  To answer further requires knowing 1065 or 1120S and reasons for negative basis and whether or not suspended losses are present.

[JulieThu]

Hi Champ,

Thanks so much for your reply. Mine begging of the year of $70K was from suspended losses from S Corp, not withdrawal. . So I have $70K “Disallowed loss” from previous years, this year offset by $5K of biz income so the end of year, I have $65K balance. My question is when I would be able to use this $65K Disallowed losses? It is the same as suspended losses right?

[LudwigVan_fan]

The suspended losses are carried forward and allowed when basis exceeds zero.  This is a complicated area to explain in just a few sentences.  I will provide some links below for reference.  But the upshot is you can't claim losses until basis exceeds zero;  while current income is claimed and reported.

https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-stock-and-debt-basis

https://www.irs.gov/instructions/i1120ssk

[Rick19744]

So the facts are still somewhat fuzzy:

• You as an investor should be maintaining a basis schedule of your basis in your S corp investment.  The instructions link provided by @LudwigVan_fan should provide some guidance.
• Your basis can never go below zero.
• One item that has not been explained is whether you are a passive investor or materially participate.  This will make a difference in how your losses are utilized on your 1040.
  • If you are a passive investor, your losses can only be utilized to the extent you have other passive income.
  • Both passive and material participant will have a floor on losses to the extent of their basis.
  • When utilizing losses there is a hierarchy in looking at whether losses can be utilized; first is basis, second is at-risk and finally the passive activity rules.
• So to address your specific question, you will be able to utilize your suspended losses to the extent you have basis / at-risk.  If you pass that hurdle and you are a passive investor,  then you will utilize suspended losses to the extent you have passive income from this K-1 or another passive investment K-1.
• Technically, you wouldn't be able to have passive activity suspended losses unless you had basis / at-risk.
• As noted by @LudwigVan_fan , this is a fairly complicated area and it may be in your best interest to consult with a tax professional at some point so you understand the rules and apply them correctly.

[JulieThu]

My lost is at risk and materially participated. If the corporation is dissolved, can I use up the suspended loss at the year it is dissolved? Thanks 

[MaryK4]

Yes, you are able to offset any passive losses against passive income in the same year or when your interest is completely disposed.  Be sure to look for the indication that indicate the SCorp/Partnership/Trust ended in 2019. @JulieThu

[Rick19744]

A little clarification here.

As was explained by @MaryK4 , you are able to utilize any suspended losses when the entity terminates / dissolves as long as you have basis.

You indicated you did have basis, so your suspended losses will be triggered in the final year.  The clarification point is that these suspended losses will be able to be utilized regardless of whether you have any other passive activity income.  

[LudwigVan_fan]

But for the current year, you have to have either positive stock basis or positive debt basis.

There are two different and distinct issues here.  First is S Corp losses in excess of basis.

The other is passive losses.  You state you materially participate, so, passive losses might not be an issue.

But, the hurdle is still the losses in excess of stock or debt basis.  You can't claim a passive loss if not allowed as a loss from the S Corp due to basis limitations.

[Rick19744 · Accepted solution]

In reading this again, we really need some clarification:

• You need to clarify why you have suspended losses.  My initial response discussed passive activity loss rules, however, your response indicates that you materially participate in the S corp.
• If that is the case, then as @LudwigVan_fan noted, you must have suspended losses as a result of no basis.
• And if that is the case, then the only way to utilize those losses is to generate income from the S corporation.  That income will provide basis and then you can offset that income with suspended losses.
• To address your overriding question, here is a simple example; $70,000 suspended losses (since you materially participate I am assuming no basis).  Income in 2019 of $10,000.  In 2019 you will report  the $10,000 of income, but then this will be offset by $10,000 of suspended losses effectively netting to zero.  You now have $60,000 in suspended losses being carried over as a result of no basis.
• Now let's say in 2020 the S corp dissolves and the K-1 generates another $5,000 in income.  Once again, you will report the $5,000 of income and offset this income with $5,000 in suspended losses and once again this nets to zero.  You now have $55,000 in suspended losses.
• At this point since you have no remaining basis, you are not able to take any of the $55,000 in suspended losses.  While you may think this is wrong, if you think about this it is correct.  You can't take more in losses than you are economically out of pocket.  That is why your basis can never go below zero.
• The example is simple, but hopefully provides some guidance to your question.

[JulieThu]

Hello Rick 19744,

  Thank you so much.  It is very clear the way you explained. Thought some where I read that you can utilize the suspended loss even due to negative basis (and not  passive loss) in the case of dissolved.