7786 / How is the basis of stock in an S corporation determined? How are the earnings, profits, distributions and redemptions of an S corporation treated?

Editor’s Note: The 2017 tax reform legislation modified the treatment of S corporations that convert to C corporations. See Q for details.

The basis of each shareholder’s stock is increased by the shareholder’s share of items of separately stated income (including tax-exempt income), by his or her share of any non-separately computed income, and by any excess of deductions for depletion over basis in property subject to depletion.¹ An S corporation shareholder may not increase basis due to excluded discharge of indebtedness income.² The basis of each shareholder’s stock is decreased (not below zero) by items of distributions from the corporation that are not includable in the income of the shareholder, separately stated loss and deductions and non-separately computed loss, any expense of the corporation not deductible in computing taxable income and not properly chargeable to capital account, and any depletion deduction with respect to oil and gas property to the extent that the deduction does not exceed the shareholder’s proportionate share of the property’s adjusted basis.

For tax years beginning after 2005, if an S corporation makes a charitable contribution of property, each shareholder’s basis is reduced by the pro-rata share of the basis in the property.³ If the aggregate of these amounts exceeds the basis in the stock, the excess reduces the shareholder’s basis in any indebtedness of the corporation to the shareholder.⁴ A shareholder may not take deductions and losses of the S corporation that, when aggregated, exceed the basis in the S corporation stock plus the basis in any indebtedness of the corporation to the shareholder.⁵ Such disallowed deductions and losses may be carried over.⁶ In other words, the shareholder may not deduct in any tax year more than what is “at risk” in the corporation.