[TheAccountant]

Baker, an individual, owned 100% of Alpha, an S corporation. At the beginning of the year, Baker’s basis in Alpha Corp. was $25,000. Alpha realized ordinary income during the year in the amount of $1,000 and a long-term capital loss in the amount of $3,000 for this year. Alpha distributed $30,000 in cash to Baker during the year. What amount of the $30,000 cash distribution is taxable to Baker?

a. $0

b. $30,000

c. $5,000

d. $4,000

The correct answer is $5,000. Can someone please explain to me why the LT capital loss cannot be utilized in the current year?

[tuanxn]

Weird, I thought the answer would have been $4,000 since the ordinary income of $1,000 would have risen the basis from $25,000 to $26,000.

Anyways, losses are deducted AFTER distributions and they cannot create a negative basis.
Since there is $25,000 of basis before the distribution, the distribution of $30,000 offsets all of the basis and Baker recognizes a $5,000 capital gain.
Baker would then have $0 basis in Alpha Corp afterwards so he cannot take the losses (since this would create a negative basis).

[marqzho]

Answer should be $4000

Initial basis $25000 + income $1000 – Distribution $30000 = Net basis $0 (no negative) & $4000 Taxable capital gain

Capital Loss will need to be deferred

=)

REG 90
FAR 95
AUD 98
BEC 84

[TheAccountant]

Sorry, the correct answer was indeed $4,000. So it doesn't matter if the loss is LT capital or ST capital correct? The only reason they were not able to use them was because there was no more tax basis remaining?

[marqzho]

You are right !

REG 90
FAR 95
AUD 98
BEC 84

[Claudia408]

@marqzho – also isn't LT/ST gain/loss a separately stated item so you wouldn't include it anyways?

BEC - 75 (3x)
AUD - 78 (3x)
REG - 67, 66, Aug 1
FAR - 54, Sept 8

[rosecpa]

That is very odd because the exact same question is featured in becker and the correct answer is 7000 which is not even a choice here. The iD is cpa-01952.
The amount is calculated 25000+1000-3000=23000 basis at year end, compared to distribution of 30000.
Can some please reconcile this? Apparently, according to becker a capital loss is included in the calculation of the basis.

[Anonymous]

This is one of the problems with the cpa exam. They r both correct and it is a subjective question unless more guidance is given. That is an election that can be made either way. U can deduct losses first if u make the election but u don't have to. Technically both answers r correct.

[marqzho]

There is one term called “ordering rule”

From IRS website:
“The order in which stock basis is increased or decreased is important. Because both the taxability of a distribution and the deductibility of a loss are dependent on stock basis, there is an ordering rule in computing stock basis. Stock basis is adjusted annually, as of the last day of the S corporation year, in the following order:
Increased for income items and excess depletion;
Decreased for distributions;
Decreased for non-deductible, non-capital expenses and depletion; and
Decreased for items of loss and deduction.”

I can't find anything in IRC, but CFR(26 CFR 1.1367-1 – Adjustments to basis of shareholder's stock in an S corporation.) said

(e) Ordering rules for taxable years beginning before January 1, 1997. For any taxable year of a corporation beginning before January 1, 1997, except as provided in paragraph (g) of this section, the adjustments required by section 1367(a) are made in the following order—
(1) Any increase in basis attributable to the income items described insection 1367(a)(1) (A) and (B) and the excess of the deductions for depletion described in section 1367(a)(1)(C);
(2) Any decrease in basis attributable to noncapital, nondeductible expenses described insection 1367(a)(2)(D) and the oil and gas depletion deduction described in section 1367(a)(2)(E);
(3) Any decrease in basis attributable to items of loss or deduction described insection 1367(a)(2) (B) and (C); and
(4) Any decrease in basis attributable to a distribution by the corporation described insection 1367(a)(2)(A).

(f) Ordering rules for taxable years beginning on or after August 18, 1998. For any taxable year of a corporation beginning on or after August 18, 1998, except as provided in paragraph (g) of this section, the adjustments required by section 1367(a) are made in the following order—
(1) Any increase in basis attributable to the income items described insection 1367(a)(1)(A) and (B), and the excess of the deductions for depletion described in section 1367(a)(1)(C);
(2) Any decrease in basis attributable to a distribution by the corporation described insection 1367(a)(2)(A);
(3) Any decrease in basis attributable to noncapital, nondeductible expenses described insection 1367(a)(2)(D), and the oil and gas depletion deduction described in section 1367(a)(2)(E); and
(4) Any decrease in basis attributable to items of loss or deduction described insection 1367(a)(2)(B) and (C).

So the one in Becker which put the distribution at the end could be the rule before 1997.

REG 90
FAR 95
AUD 98
BEC 84

[marqzho]

There is one term called “ordering rule”

From IRS website:
“The order in which stock basis is increased or decreased is important. Because both the taxability of a distribution and the deductibility of a loss are dependent on stock basis, there is an ordering rule in computing stock basis. Stock basis is adjusted annually, as of the last day of the S corporation year, in the following order:
Increased for income items and excess depletion;
Decreased for distributions;
Decreased for non-deductible, non-capital expenses and depletion; and
Decreased for items of loss and deduction.”

I can't find anything in IRC, but CFR(26 CFR 1.1367-1 – Adjustments to basis of shareholder's stock in an S corporation.) said

(e) Ordering rules for taxable years beginning before January 1, 1997. For any taxable year of a corporation beginning before January 1, 1997, except as provided in paragraph (g) of this section, the adjustments required by section 1367(a) are made in the following order—
(1) Any increase in basis attributable to the income items described insection 1367(a)(1) (A) and (B) and the excess of the deductions for depletion described in section 1367(a)(1)(C);
(2) Any decrease in basis attributable to noncapital, nondeductible expenses described insection 1367(a)(2)(D) and the oil and gas depletion deduction described in section 1367(a)(2)(E);
(3) Any decrease in basis attributable to items of loss or deduction described insection 1367(a)(2) (B) and (C); and
(4) Any decrease in basis attributable to a distribution by the corporation described insection 1367(a)(2)(A).

(f) Ordering rules for taxable years beginning on or after August 18, 1998. For any taxable year of a corporation beginning on or after August 18, 1998, except as provided in paragraph (g) of this section, the adjustments required by section 1367(a) are made in the following order—
(1) Any increase in basis attributable to the income items described insection 1367(a)(1)(A) and (B), and the excess of the deductions for depletion described in section 1367(a)(1)(C);
(2) Any decrease in basis attributable to a distribution by the corporation described insection 1367(a)(2)(A);
(3) Any decrease in basis attributable to noncapital, nondeductible expenses described insection 1367(a)(2)(D), and the oil and gas depletion deduction described in section 1367(a)(2)(E); and
(4) Any decrease in basis attributable to items of loss or deduction described insection 1367(a)(2)(B) and (C).

So the one in Becker which put the distribution at the end could be the rule before 1997.

REG 90
FAR 95
AUD 98
BEC 84

[rosecpa]

So in other words, the current ordering rules determine that the loss adjustment to the basis is made after the distribution which would leave a negative basis in the stock?

If you don't incorporate the loss before the distribution, you are both taxed on the excess distribution, and not afforded the benefit of the capital loss.

[rosecpa]

Is there a possibility of having a negative basis in a S Corporation? If not, what happens to that loss?

[Anonymous]

Basis can never be negative. Losses are suspended and carried forward until they can be utilized. Also Always remember to keep debt and stock basis separate so I can advise on cap gain issues

[rosecpa]

But why does it make sense to suspend the loss, but pay tax on the gain? shouldn't they both be accounted for in the same time period?
The real question is-is the becker answer and explanation still correct?

[Author]

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