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federal income tax purposes.

The amount of shareholder losses related to an S corporation that can be deducted are limited in a
number of ways.

older can only deduct

losses up to his total adjusted basis in the S corporation.

debt basis, additional

losses can be deducted up to that amount. Debt basis is created when a shareholder loans his own funds
to the S corporation or is personally responsible for S corporation debt. Only loans for which the
. If the shareholder is not personally
liable for the debt, it cannot be used to increase his debt basis in the S corporation.

Unused losses due to inadequate basis carry forward indefinitely until either the adjusted basis of the
stock increases or the S election is revoked.

Later increases in basis (created, for example, by S corporation income or shareholder contributions of
capital) must first be used to restore debt basis up to its original amount. Once debt basis is restored,
stock basis can begin to be restored.

Example: Elijah owned 100% of an S corporation. At the beginning of the year, his adjusted basis in the S
corporation was $25,000. During the year, the S corporation had $1,000 of ordinary income, a $3,000
long-term capital loss, and distributed $30,000 in cash to Elijah. What amount of this $30,000
distribution is taxable to Elijah?

resulting in $26,000 in basis at year end.

must be taxed. The $3,000 capital loss is suspended indefinitely until Elijah has enough basis in the S
corporation to deduct it.

The stock basis of the shareholder in an S corporation is increased by:

All income items, whether taxable of not,
Any additional contributions of assets, including cash.

The stock basis of the shareholder in an S corporation is decreased by:

Distributions which are not part of gross income,
All taxable losses and deductions,
Nondeductible expenses that are not charged to capital.

Hint: A shareholder cannot deduct a share of the ordinary loss on their individual tax return, unless it
has basis before deduction the share of the ordinary loss. In other words, the loss that is deductible on
Form 1040 is limited to the adjusted basis, before the loss deduction. Any ordinary loss that was not
deductible on Form 1040 can be carried forward indefinitely or, until the taxpayer gets basis.

1) Increased for all income items, whether taxable or not.

2) Decreased for all distributions which are not part of gross income.
3) Decreased for capital items which are not deductible (withdrawal of assets).

REG 5.64
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