S corporation shareholders track two separate basis accounts, stock basis and debt basis, that together determine how much loss they can deduct and whether distributions trigger gain. Mastering the ordering rules and adjustment mechanics is essential for exam success.
AICPA Representative Tasks (verbatim). 1. Application, Calculate the impact on a shareholder's stock basis in an S corporation for tax purposes resulting from contributions of noncash property, including an S corporation's assumption of debt on the contributed property. 2. Application, Calculate the impact on a shareholder's stock basis in an S corporation for tax purposes resulting from nonliquidating distributions of noncash property. 3. Application, Calculate the impact on a shareholder's debt basis in an S corporation for tax purposes resulting from loans made by a shareholder to an S corporation.
A shareholder's initial stock basis depends on how the stock was acquired. The three most common acquisition methods yield different starting points:
KEY: Property contributions follow §351 substituted basis rules. The shareholder takes a carryover basis equal to the property's adjusted basis in the contributor's hands, not its fair market value.
Common mistakes
- Counting loan guarantees as debt basis. Only direct loans from shareholder to corporation create debt basis. Guarantees of bank loans or third-party debt provide no basis. Trap: "I guaranteed the loan, so I have basis." Correct: guarantees create zero debt basis.
- Increasing stock basis before restoring debt basis. When debt basis was previously reduced by losses, subsequent income must restore debt basis to its original face amount before any income can increase stock basis. Trap: "income increases stock basis first." Correct: restore debt basis first, then stock basis.
- Using property's FMV for initial contributed basis. Property contributions create stock basis equal to the property's adjusted basis in the shareholder's hands, not fair market value. Trap: "I contributed property worth $100,000, so my basis is $100,000." Correct: basis equals the property's adjusted basis.
Bottom line
- Initial stock basis equals cash plus the adjusted basis of contributed property, reduced by liabilities the S corporation assumes on that property
- Under §357(c), assumed liabilities exceeding the contributed property's adjusted basis are recognized as taxable gain
- Stock basis increases for income items (ordinary, separately stated, tax-exempt) and capital contributions; decreases for distributions, nondeductible expenses, and deductible losses
- Debt basis arises only from direct shareholder loans to the S corporation; guarantees and related-party loans create no debt basis
Exam shortcut
"IDLES" for decrease ordering: After increases, apply decreases in this order: (I)ncome already added, (D)istributions, (L)osses-nondeductible expenses, (E)xpenses-deductible losses, (S)uspend any excess. This ensures you never skip nondeductibles before losses. Direct loan test: Ask "Did the shareholder write a check to the corporation?" If yes, debt basis exists. If the bank wrote the check (even with shareholder guarantee), no debt basis. Guarantees are red herrings on the exam.
The full lesson (about 2,628 words, 18 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- II.B1
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