If you have a business, you’ve probably thought about business structures. And if you’ve thought about business structures for a business or real estate that is run like a business, you’ve undoubtedly heard about an S Corporation.
For years, that’s been the “go to” structure for businesses, either S Corporations or more recently, LLCs that elect to be taxed like an S Corp.
They are flow-through entities. That means the income or expense for the corporation gets reported on the shareholder’s tax returns. If it’s you and a partner, 50/50, on an S Corporation or LLC-S (LLC taxed like an S Corp), you each get half of the income or loss to report on your return.
And for most people, they just go ahead with that and don’t think about additional planning issues.
There are several. One has to do with your basis in your S Corp.
Here’s a recent example for a client of mine who came with a big tax issue. How come he was paying so much in taxes? It almost looked like his accountant had forgotten to report his big loss on his S Corp. What happened?
The accountant had properly prepared his return. And, yep, sure enough, there was no loss flowing through from the S Corporation.
But the S Corp HAD a loss. What happened?
The problem was lack of planning.
You need two things in order to take advantage of an S Corp loss. You need to show you actively participate in the S Corp and that you have sufficient basis. The active participation is a pretty easy standard. The basis, though, that’s a little tougher.
First of all, you need to make sure you’ve got it tracked accurately. It then needs to be reported with your tax return. However, in the past, some of the numbers might not have been accurately reported on the tax return. So the carry-over numbers are wrong. That could mean it doesn’t show that you have enough basis for the loss to be deductible on your return.
That wasn’t this client’s problem in this case however.
Instead, he didn’t realize that the way he took the loan he used to float the shortfall could have devastating results for his taxes.
He got a line of credit for his business and used that money to put in the business. That’s how the S Corp was able to stay in business even though it had a big loss.
And he had personally guaranteed the loan.
There are two ways that you can have basis. One is equity basis. That’s how much you paid or contributed for the initial stock plus how much income you’ve left in the business minus the distributions taken over time. That’s how the rollover basis is calculated and why that is so important.
The second method is debt basis. That’s how much you’ve loaned to the business.
Notice that it’s not how much of a loan you’ve guaranteed for the business, but how much you personally have put in the business.
In this case, my client didn’t have enough equity basis to deduct the loss, so he needed to add debt basis. That meant the loan was important. But it couldn’t be from a bank to the S Corp. It needed to be from the bank to him and then he personally put the money in the S Corp.
Just that simple little change would have made all the difference.
Luckily we were talking before year end so this mistake could get corrected for the current year. The previous year, though, had to be just considered a learning lesson.
The loss from the previous year wasn’t lost completely but was allowed as a suspended loss. Again, though, there needed to be enough basis in the current year so he could take it now.
Good news is that now there would be.
If he’d waited one more year to talk to me in a consultation, he would have lost it for another year.
How much could a consultation save you? In this case, it was tens of thousands of dollars.
Or, if a consultation is not right for you now, the coaching program gives you home study courses plus an opportunity to discuss your personal situation in a group setting.
For a consultation, you can book now by going to: https://www.ustaxaid.com/consultation/
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