An S shareholder can deduct losses only to the extent of his basis in his stock plus his basis in any debt the corporation owes him. § 1366(d)(1). Excess losses are carried forward indefinitely. § 1366(d)(2).
Basis is increased by the shareholder’s share of income and gain (including tax‑exempt income) and decreased by distributions, losses, and nondeductible expenses. § 1367(a). The order of adjustments is important: first increase for income, then decrease for distributions, then for nondeductible expenses, and finally for losses. Reg. § 1.1367‑1(f).
What about corporate debt? An S shareholder gets basis for debt only if the corporation is directly indebted to the shareholder. Guarantees don’t count. In Estate of Leavitt v. Commissioner, 875 F.2d 420 (4th Cir. 1989), the shareholders guaranteed a bank loan to the corporation. The court held that a guarantee is not an economic outlay, so the shareholders didn’t get basis. The bank looked to the corporation for repayment, not the shareholders.
How can shareholders get basis for debt? They should borrow the money themselves and then lend it to the corporation – a “back‑to‑back” loan. Then the corporation owes the shareholders directly, and they have basis.
Also, a shareholder’s basis in S corporation debt is reduced by losses, but increased by subsequent income only after the shareholder’s stock basis is restored. § 1367(b)(2)(B). So if you have both stock and debt, keep track of both.
This article is for general informational purposes only and is subject to change. Tax laws are complex and vary by situation. You should consult a qualified professional for advice specific to your circumstances. For questions, contact Alan Goldstein.
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