An S corp reports a $90,000 loss. The 100% shareholder has $50,000 of stock basis and personally guaranteed a $200,000 bank loan. They deduct the full $90,000, wrong by $40,000. Guaranteed loans give zero debt basis, so only $50,000 of loss clears the basis hurdle.
Basis answers two questions every S corp shareholder asks each year. How much loss can I deduct? Is my distribution taxable? Get the running total wrong and every downstream calculation breaks. S corp basis has two components: stock basis and debt basis. Treating them as one bucket is the most common shareholder-basis mistake on REG.
Initial stock basis equals what the shareholder paid or contributed:
- Cash. Basis equals cash paid. A shareholder who pays $60,000 for 60% of a new S corp starts at $60,000.
- §351 property contribution. Basis equals the adjusted basis of the property (not FMV), reduced by liabilities the corporation assumes.
- Inherited stock. Basis equals FMV at the decedent's date of death (§1014 step-up).
Common mistakes
- Counting a personal guarantee as debt basis. A shareholder guarantees a $300,000 bank loan and claims $300,000 of debt basis. Wrong by $300,000, only direct shareholder loans create debt basis. The guarantee gives zero until the shareholder actually pays the bank.
- Running the four steps in the wrong order. Increasing basis for income, then deducting losses, then subtracting distributions inverts steps 2 and 4. The correct order is income → distributions → nondeductible expenses → losses. Subtracting losses first can drive basis negative and incorrectly convert a tax-free distribution into capital gain.
- Restoring stock basis before debt basis. A shareholder zeroes both buckets, then sees $50,000 of income next year, and routes it all to stock leaving debt at $0. Debt restores first up to the original principal; stock is residual. Mis-routing hides phantom gain on a future loan repayment.
Bottom line
- Stock basis starts at cash cost or the carryover adjusted basis of §351 contributed property, never FMV.
- Annual stock basis: add pro rata income (including tax-exempt), subtract distributions, subtract nondeductible expenses, subtract deductible losses. Never below zero.
- Adjustment order: (1) income, (2) distributions, (3) nondeductible expenses, (4) losses.
- Debt basis exists only for direct shareholder-to-corporation loans. Personal guarantees of bank loans give zero debt basis until the shareholder actually pays.
Exam shortcut
When a question mentions a shareholder guaranteeing a bank loan, the answer treats the guarantee as zero debt basis. Eliminate any choice that adds the guaranteed amount to basis. For loss-deduction questions, compute total basis (stock + debt) at year-end before the loss step. If the loss exceeds total basis, the deductible amount equals total basis and the rest suspends.
The full lesson (about 2,400 words, 16 min read) adds 1 worked example, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- V.C3
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