In essence, the ordering rule allows shareholders to "borrow" basis from anticipated net income at the end of the year while receiving distributions during the taxable year.
However, if losses occur subsequent to the distribution, and those losses result in a net loss for the taxable year, the distribution (which the shareholder anticipated to be tax- free) could be converted into a taxable distribution. Under the partnership rules, however (unlike the S corporation rules), for any taxable year, a partner's basis is first increased by items of income, then decreased by distributions, and finally is decreased by losses for that year. Giant, Inc., an S Corporation, has only one shareholder, Linda Fath.
Linda had a 7,000 stock basis at the beginning of 1992.
The proposals list an ordering rule for the adjustment, either increases or decreases, of stock basis.
They also include provisions on the timing of basis adjustments, basis computations during a loss year, computation of individual stock basis and the categorization of debt as basis.
The Timing of Basis Adjustments All basis adjustments are deemed to occur on the last day of the corporation's tax year or on the date the shareholder sells his or her stock, if earlier.
Income and loss items affect basis first, followed by distributions.
Determining Individual Stock Basis As with C corporation stock acquisitions, an S corporution shareholder may have different bases in separately acquired shares of stock.
As a result, the tax treatment of distributions will differ depending on the stock's basis (i.e., a distribution could generate a taxable gain for stock with a low basis, while at the same time be a tax-free retum of capital for stock with a high basis).
The amount of the tax basis determines the tax treatment of such items as flow-through losses and corporate distributions.
Many S shareholders have two investments in the corporation - the investment in corporate stock and loans made to the corporation.
The stock basis is reduced by the amount of any separately or non-separately stated loss items.