Stock and debt basis is used to calculate how much loss you can deduct on your personal return in years that your business reports a net loss. It's also used to determine how much of a capital gain you'd have if you sold the business.
Each year the business has a profit, you pay tax on your share - regardless of whether you took distributions or not. This increases your stock basis, which tracks your after tax investment in the business. You'll receive a Schedule K-1 which shows your share of the income and expense items of the business. The information from the Schedule K-1 is entered on your tax return and that's how that IRS will know what you're taxed on for the year.
