The importance of S corporation basis and distribution elections

Details

Published: 04 December 2020 04 December 2020

S corporations may provide tax advantages over C corporations. This can be true if you expect the business to incur losses because C corp. shareholders generally get no tax benefit from losses. Conversely, S corp. shareholders can deduct their share of these losses on personal tax returns to the extent of their basis in the stock and any loans they make to the entity. So the ability to use losses that pass through from an S corp. depends on your basis in the corporation's stock and debt. Be aware that there are some elections available to an S corp. or its shareholders that can affect the basis adjustments caused by distributions and other events. Contact us if you’d like more information.

Losses that can’t be deducted because they exceed your basis are carried forward and can be deducted by you when there’s sufficient basis. Therefore, your ability to use losses that pass through from an S corporation depends on your basis in the corporation’s stock and debt. And, basis is important for other purposes such as determining the amount of gain or loss you recognize if you sell the stock. Your basis in the corporation is adjusted to reflect various events such as distributions from the corporation, contributions you make to the corporation and the corporation’s income or loss. Adjustments to basis However, you may not be aware that several elections are available to an S corporation or its shareholders that can affect the basis adjustments caused by distributions and other events.

Here is some information about four elections:

An S corporation shareholder may elect to reverse the normal order of basis reductions and have the corporation’s deductible losses reduce basis before basis is reduced by nondeductible, noncapital expenses. Making this election may permit the shareholder to deduct more pass-through losses.

An election that can help eliminate the corporation’s accumulated earnings and profits from C corporation years is the “deemed dividend election.” This election can be useful if the corporation isn’t able to, or doesn’t want to, make an actual dividend distribution.

If a shareholder’s interest in the corporation terminates during the year, the corporation and all affected shareholders can agree to elect to treat the corporation’s tax year as having closed on the date the shareholder’s interest terminated.

This election affords flexibility in the allocation of the corporation’s income or loss to the shareholders and it may affect the category of accumulated income out of which a distribution is made. An election to terminate the S corporation’s tax year may also be available if there has been a disposition by a shareholder of 20% or more of the corporation’s stock within a 30-day period.

Contact us if you would like to go over how these elections, as well as other S corporation planning strategies, can help maximize the tax benefits of operating as an S corporation. © 2020