582 MODULE 36 TAXES: CORPORATE

EXAMPLE: An S corporation incurred a loss of $20,000 for 2008. Its sole shareholder (who materially par-
ticipates in the business and is at-risk) had a stock basis of $10,000 and debt with a basis of $15,000. The
pass-through of the $20,000 loss wouldfirst reduce stock basis to zero, and then reduce debt basis to $5,000.
Assume that for 2009, the same S corporation had ordinary income of $10,000, and made a $4,000 cash
distribution to its shareholder during the year. The first $4,000 of basis increase resulting from the pass-
through of income would be allocated to stock in order to permit the $4,000 distribution to be nontaxable.
The remaining basis increase (net undistributed income of $6,000) would restore debt basis to $11,000 (from
$5,000).
2. The deductibility of S corporation losses is also limited to the amount of the shareholder's at-risk
basis at the end of the taxable year [Sec. 465].
(1) A shareholder's amount at-risk includes amounts borrowed and reloaned to the S corporation
if the shareholder is personally liable for repayment of the borrowed amount, or has
pledged
property not used in the activity as security for the borrowed amount.
(2) A shareholder's amount at-risk does not include any debt of the S corporation to any person
other than the shareholder, even if the shareholder guarantees the debt.
3. Thedeductibility of S corporation losses may also be subject to the passive activity loss limita-
tions [Sec. 469]. Passive activity losses are deductible only to the extent of the shareholder's in-
come from other passive activities (See Module 33).
(1) Passive activities include (a) any S corporation trade or business in which the shareholder does
not materially participate, and (b) any rental activity.
(2) If a shareholder "actively participates" in a rental activity and owns (together with spouse) at
least 10% of the value of an S corporation's stock, up to $25,000 of rental losses may be
de-
ductible against earned income and portfolio income.
4. A shareholder's S corporation stock basis is increased by all income items (including tax-exempt
in-
come), plus depletion in excess of the basis of the property subject to depletion; decreased by all loss
and deduction items, non deductible expenses not charged to capital, and the shareholder's deduction
for depletion on oil and gas wells; and decreased by distributions that are excluded from gross in-
come. Stock basis is adjusted in the following order:
5. Increased for all income items
6. Decreased for distributions that are excluded from gross income
7. Decreased for nondeductible, noncapital items
8. Decreased for deductible expenses and losses
EXAMPLE: An S corporation has tax-exempt income of $5, 000, and an ordinary loss from business activity of
$6,000 for calendar year 2009. 1ts sole shareholder had a stock basis of $2,000 on January 1, 2009. The $5,000 of
tax-exempt income would pass through to the shareholder, increasing the shareholder's stock basis to $7,000, and
would permit the pass-througli and deduction of the $6,000 of ordinary loss, reducing the shareholder's stock basis
to $1,000.
EXAMPLE: An S corporation had an ordinary lossfrom business activity of $6,000 and made a $7,000 cash dis-
tribution to its sole shareholder during calendar year 2009. The sole shareholder had a stock basis of $8,000 on
January 1,2009. The $7,000 cash distribution would be nontaxable and would reduce stock basis to $1,000. As a
result, only $1,000 of the $6,000 ordinary loss would be allowable as a deduction to the shareholder for 2009. The
remaining $5,000 of ordinary loss would be carriedforward and deducted by the shareholder when there is stock
basis to absorb it.
9. The treatment of distributions (Cash + FMV of other property) to shareholders is determined as
fol-
lows:
10. Distributions are nontaxable to the extent of the Accumulated Adjustments Account (AAA) and
are applied to reduce the AAA and the shareholder's stock basis.
(1) The AAA represents the cumulative total of undistributed net income items for S corporation
taxable years beginning after 1982.
(2) If there is more than one distribution during the year, a pro rata portion of each distribution is
treated as made from the AAA.
(3) The AAA can have a negative balance if expenses and losses exceed income.
(4) No adjustment is made to. the AAA for tax-exempt income and related expenses, and Federal
taxes attributable to a year in which the corporation was a C corporation. Tax-exempt
income
and related expenses are reflected in the corporation's Other Adjustments Account
(OAA).