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A few weeks ago, I posted Question 1 to the forum and Roger CPA review and got a reasonable response as to why $4000 was the correct answer. It had to do with following the IRS’s order of S-corp distributions. (Income-Distribution – losses.) I followed that logic for Question 2 and got the answer wrong. Below are the questions, answers, and explanations.
Can somebody please explain why the answers are different?
Question 1
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: $4000
Roger’s CPA REVIEW Answer:
Baker’s basis is increased by Alpha’s ordinary income of $1,000, resulting in a basis of $26,000. The long-term capital loss is a pass-through item and does not affect basis. The $30,000 distribution exceeds Baker’s basis by $4,000 and will be taxable as a long-term capital gain, indicating that $4,000 of the distribution is taxable to Baker. The $3,000 long-term capital loss incurred by Alpha passes through to Baker and may be used to offset capital gains and may be partially or fully deductible
Hi ironyanis,
“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:
1.Increased for income items and excess depletion;
2.Decreased for distributions;
3.Decreased for non-deductible, non-capital expenses and depletion; and
4.Decreased for items of loss and deduction.”
Pass-through items of income, losses and deductions are added to or subtracted from beginning basis before determining the tax treatment of any distributions during the year (assuming there were no accumulated earnings and profits carried forward).
Baker’s basis in Alpha was increased by Baker’s 100% share of Alpha’s income (+$1,000) resulting in a pre-distribution basis of $26,000. The cash distribution exceeded Baker’s basis by $4,000, so $4,000 of the cash distribution is treated as a capital gain. The remaining $3,000 capital loss will be carried forward until it can be absorbed by S-Corp gains.
Note that the $3,000 long-term capital loss is NOT deductible to Baker because the distribution reduced his stock basis to zero, and would be carried forward.
I hope this helps,
Roger CPA Review Team
Question 2 (Same as question 1)
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: $7,000
Distributions to S corporation shareholders cannot reduce stock basis below zero. Distributions in excess of basis are taxable. IRC Section 1368 Items that increase S corporation shareholder basis include income of the corporation that is not separately computed. In this case, there is $1,000 of ordinary income. IRC Section 1367(a)(1) Items that decrease S corporation shareholder basis include loss and deduction items of the corporation that are separately stated and distributions up to but not exceeding basis. In this case, these are $3,000 longterm capital loss and $23,000 of the cash distribution.
IRC Section 1367(a)(2)
The taxable portion of the $30,000 cash distribution to Baker is calculated as follows:
Basis at beginning of year $ 25,000
Ordinary income 1,000
Long‐term capital loss ‐3,000
Basis remaining 23,000
Cash distribution ‐30,000
Taxable distribution in excess of basis 7,000
‐‐‐‐‐‐‐‐
Basis at end of year $ 0
The $7,000 distribution in excess of basis would be taxable.
AUD 91
FAR 80
BEC 79
REG 84
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