S-corp "negative basis"

[Max W]

Client rec'd K-1 with a  $60K, Box 1 loss.  Basis at BOY was $6K. So, client is entitled to a $6K loss.  

In the CPA's letter she states that the $60K loss should be reported as a CG.  

As I understand it, the Basis loss should be CFWD to the following years and only reported as CG on dissolution of the S-corp.

Shouldn't the CPA amend the K-1 and the 7203?

 

[Lee B]

The CPA may be correct. The big question is what other balance sheet liabilities exist?

If the stockholder loaned the S Corp funds, then the stockholder has debt basis which exceeds stock basis which might support a bigger loss deduction.

If the S Corp borrowed funds directly then the CPA is correct.

 

[Max W]

There were no loans or any other complications.    The  client had a similar situation a few years ago with a different accountant and the negative basis was carried forward to the next year where it was wiped out by a large gain.

 

[Lee B]

I don't understand. If there were no loans, there must have been some other liabilities in significant amounts otherwise liabilities plus equity would have had a debit balance

and total assets would have been negative. Without seeing the balance sheet, who knows?

[Max W]

3 hours ago, cbslee said:

I don't understand. If there were no loans, there must have been some other liabilities in significant amounts otherwise liabilities plus equity would have had a debit balance

and total assets would have been negative. Without seeing the balance sheet, who knows?

well, I don't understand it either.   The old CPA's worksheet from 2020 specifically showed the loss as a carry over.

I'll have to get a copy of the B/S to see what is going on.

[Max W]

This comes from Tax Advisor, Feb 1. 2022

Computing shareholder basis

Under the normal computation rules, basis is computed by taking beginning basis and adding the items of income, reducing that by nondividend distributions; by nondeductible, noncapital expenses; and, finally, by any other loss and deduction items. Basis cannot be reduced below zero by nondividend distributions; nondeductible, noncapital expenses; and any other loss and deduction items.

Distributions in excess of stock basis are treated as a gain from the sale or exchange of property and reported as a capital gain. The capital gain is long-term or short-term depending upon the shareholder's holding period in the stock.

Loss and deduction items in excess of basis are suspended under Sec. 1366(d)(2) until the next tax year and are carried forward to each succeeding tax year until the shareholder has basis.

If a shareholder completely disposes of the stock while loss and deduction items are suspended under Sec. 1366(d)(2), the loss and deduction items are permanently lost and may not be claimed. Any loss and deduction items suspended under Sec. 1366(d)(2) cannot be used to offset the gain on the sale of the stock.

https://www.thetaxadviser.com/issues/2022/feb/s-corporation-shareholder-recomputation-basis.html

If you read on. It seems that this is a murky area where the IRS hasn't given sufficient guidance.

[Lee B]

Distributions in excess of basis definitely are treated as capital gain.

Were there any distributions during the year?

[jklcpa]

12 hours ago, Max W said:

Basis at BOY was $6K. So, client is entitled to a $6K loss. 

Not necessarily. Ordering rules come into play in calculating shareholder s corp basis to determine if any loss is allowed. 

I agree with cbslee that we need information about distributions. 

[Corduroy Frog]

"Loan basis" should not be a factor unless the shareholder actually effectively loaned the money to the corporation himself (herself).  This differs from a partnership where a partnership loan can be added to basis simply by the partner's guarantee on the loan.

[Abby Normal]

21 hours ago, Max W said:

Shouldn't the CPA amend the K-1 and the 7203?

1120S doesn't include a 7203, only 1040. Unless the 7203 was prepared as part of the K1 for convenience or in lieu of a basis worksheet. And I agree with you that the loss is simply carried forward and does not create a capital gain. Distributions in excess of basis should be the only capital gain issue here.

And, being pedantic, basis can not be negative. It stops at zero.

[Max W]

15 hours ago, cbslee said:

Distributions in excess of basis definitely are treated as capital gain.

Were there any distributions during the year?

Distibution of $20,000 (line 6 form 7203 excludes dividend distributions).

[Max W]

To confound the issue even more, Part 3 of 7203, shows the loss as a carryover (Line 36 Col e)

[Max W]

The balance sheet shows Total assets $180K, Liabilities of $330K and Equity $-150K.  The Liabilities are ALL Loans.

[jklcpa]

If some or all of those loans created debt basis, and if that basis is less than the amount owed...

then the repayment of debt during the year will be cap gain if the debt is evidenced in writing. If not formalized, then the resulting taxable amount would be ordinary income. 

Could that be what is happening?

[mircpa]

@Max W

If all liabilities are loans that means owners do not have stock basis. Equity of negative 150K could comprise of previous years and current year losses.

You should also look at past years 7203's. Double check outside entities loan balances at year end, may be they might have miscategorized shareholders loans as outside loans.

[Max W]

18 hours ago, jklcpa said:

If some or all of those loans created debt basis, and if that basis is less than the amount owed...

then the repayment of debt during the year will be cap gain if the debt is evidenced in writing. If not formalized, then the resulting taxable amount would be ordinary income. 

Could that be what is happening?

Unfortunately, there is no debt basis provided on 7203, part 2.  I can't imagine that there were no payments on credit cards and a LOC. There is also a SBA EIDL loan and a item simply marked loan payable.   I will be doing some more digging.

16 hours ago, mircpa said:

@Max W

If all liabilities are loans that means owners do not have stock basis. Equity of negative 150K could comprise of previous years and current year losses.

You should also look at past years 7203's. Double check outside entities loan balances at year end, may be they might have miscategorized shareholders loans as outside loans.

Yes, there may be a lot of problems here.  As I said, I will be digging for more info that I do no have in my possession as yet.  To confound things even more, the client's brother died suddenly and client has gone out of town for funeral.

[jklcpa]

None of the loans mentioned would create debt basis for an s corp shareholder. Debt basis comes from the shareholder loaning money to the s corp.