The Importance of S Corporation Basis and Distribution Elections

The Importance of S Corporation Basis and Distribution Elections

  • Find out how S corporations can provide tax benefits over C corporations.
  • Learn about four elections available to S corporations and their shareholders that can affect basis adjustments.

S corporations can provide tax advantages over C corporations in the right circumstances. This is true if you expect that the business will incur losses in its early years because shareholders in a C corporation generally get no tax benefit from such losses. Conversely, as an S corporation shareholder, you can deduct your percentage share of these losses on your personal tax return to the extent of your basis in the stock and any loans you personally make to the entity.

Losses that can’t be deducted because they exceed your basis are carried forward. You can deduct them 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, the importance of basis has other purposes. These purposes include determining the amount of gain or loss you recognize if you sell the stock. Your basis in the corporation will adjust to reflect various events such as distributions from the corporation, contributions you make to the corporation, and the corporation’s income or loss.

The importance of S corporation basis and distribution elections

Adjustments to basis for an S corporation

If you’re not aware of several elections that can affect basis adjustment, your Fiducial representative can tell you more. These elections are available to an S corporation or its shareholders, and they can affect the basis adjustments caused by distributions and other events. Below you will see information about four of these elections:

  1. An S corporation shareholder may elect to reverse the normal order of basis reductions and have the corporation’s deductible losses reduce basis before reducing the basis by nondeductible, noncapital expenses. Making this election may permit the shareholder to deduct more pass-through losses.
  2. We call an election that can help eliminate the corporation’s accumulated earnings and profits from C corporation years the “deemed dividend election.” You will find this election useful if the corporation can’t, or doesn’t want to, make an actual dividend distribution.
  3. 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. It may also affect the category of accumulated income out of which a distribution may come.
  4. 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.

Next steps

Would you 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? Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations.

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