welcome back to accounting to this video
called the S corp basis this lesson I
have to warn you it's gonna be really
boring and it is one of those really dry
topics in tax that I need to teach you I
need to show you I need I need you to
understand pieces of how this stuff
works but just know as we go through
this Halon and the CPA is behind Halon
this is one of the main things they're
watching for they're watching to see if
there's a tax return that comes across
our desk that does not have enough basis
to cover distributions or a loss or
something like that so we are watching
for this we are calculating this we are
you know not going to make this a part
of your day every time we do a tax
return but it is something we're
watching however you need to have some
idea of what it is how it works all of
that so bear with it I don't think this
is a terribly long video but at the same
time I gotta warn you it's gonna be a
little boring but let's jump into it
let's make the best of it and then I've
got some more exciting things for you in
accounting too so first I thought we
would cover why we need to understand
basis it's important during the tax year
because it must be there to offset
distributions and losses so think of
basis as a good thing
think of basis as something that covers
you that more basis you have the better
in almost anything I would think so
in this first bullet the first reason we
need it is to cover distributions this
means that if I take money out of the S
corp in the form of a dividend a
distribution if I want that to not be
taxable then I need to have basis now
this doesn't mean that the taxpayer
doesn't pay tax
on on income the the the taxpayer is
going to be paying on the net profit
whatever the S corporation is making but
this is you could take a distribution
and if you don't have enough basis not
only do you have to pay tax on the
income the escort made you also pay tax
on the distribution crazy right it's
kind of like being double taxed so
having having this basis is important in
the first piece of this that we're going
to cover here is the distribution side
of it you have to have enough basis to
cover whatever distributions you take
out of the company the same thing when
it comes to if the S corporation runs a
loss for the year like loss meaning
expenses were more than income right
that kind of loss you have a net loss if
the S Corp did not have basis to cover
that loss then it is not allowed or part
of it may not be allowed to be taken in
that tax year and that's bad too right
because that loss could reduce income
from other sources for the shareholder
and the taxpayer ends up paying more tax
because they couldn't enjoy all of these
losses that this S corporation was
creating and that can be just as bad as
an extra tax right it definitely can be
so covering losses as the second piece
and the third issue is when the company
is sold this is a this is a less common
issue but you know one that must be
taken into account as it will determine
the gain on the sale of the company so
if you're if you have $20,000 basis and
you sell the company for $40,000 your
gain is the difference between the two
that make sense so basis is important
whenever you're selling the company as
well so that's the those are the three
reasons we need to think about basis let
me kind of show you how we calculate
basis and then here too
but I'm gonna take you through some
examples of each of these and you'll
understand it a little bit better so
kind of think about basis like a
checking account the account goes up and
down it can never go negative okay let
me say that again it can never go
negative when there's a de positive
income okay when you when the business
makes money the basis goes up for all
the shareholders based on a percentage
of their ownership but just know that
the basis goes up as you earn money when
there's a payment of an expense the
basis goes down so just like a checking
account income basis up expense basis
down when a shareholder contributes
money to the company right like let's
say the shareholder puts money in the
basis does what it goes up when the
shareholder withdrawals money the basis
goes down basis can also be decreased by
several you know kind of different
activities like any penalties that the
company has to pay section 179 expense
you remember that from depreciation
bonus depreciation all of that there's
there's the non-deductible portion of
meals so meals are only 50% deductible
but that other 50% that actually
decreases basis still does it it's not
deductible but it decreases basis so you
know kind of be aware that you know all
the meals you're eating out and
deducting through the business half of
those meals are eating up your basis now
you know is it is it the worst thing in
the world because you still had an
outflow so I'm not I'm not trying to
make the point of hey don't don't deduct
business meals I'm just saying when it
comes to basis you need to know that
that is a that is an outflow that you
know a hundred percent of whatever you
spend on meals so kind of think of it
like this in year one you start out with
zero basis right when you first start
the company for the activity of the
first year in business you then have an
ending basis so whatever the income and
the expenses and how much money you put
in how much money you took out that's
what the end-of-the-year basis is the
ending basis in
year one this may be intuitive but let
me say this the ending basis in year one
is your beginning basis for year two
that make sense it just and it continues
it's like a running ledger all the time
this continues as long as you have
personal ownership of the company so on
the screen I have a worksheet that kind
of gives you an idea of all the ways
basis goes up and down and you can just
take a look at it here while I'm talking
and kind of just see all the things that
make it go up all the things that make
you go down and kind of just have it in
the back of your mind what matters most
is what the basis is at the end of each
year because based on that we we may we
may have to we may find out we have a
problem
right after we figure out what the basis
is at the end of the year if we've got
distributions that exceed our basis that
kind of thing we may have a taxable
event and that's kind of the reason I'm
teaching you this is to be aware of what
creates the bad guys and I'm gonna show
you kind of towards the end how like the
real things to be looking for let me
show you first an example of this
distribution issue like when you run out
of basis when you do distributions so
most s Corpse have basis at the end of
the year then what we do we take a look
at what their distributions were now
keep in mind we're not talking about
payroll okay we talked a lot about
payroll and other lessons right we're
not talking about payroll here we're
talking about the actual distributions
from the S Corp that are exempt from
self-employment tax okay
when you have enough basis those
distributions reduce basis further but
so long as it does not as so long as
your basis doesn't go negative
everything's fine and you move on to the
next year you figure out what your your
ending basis is after all your
distributions that becomes next year's
beginning basis and you move on and it
doesn't matter and that's what 99% of
your clients are going to be but let's
say that you have distributions in
excess of this basis that amount that's
in excess
is taxed at the at the capital gain rate
okay so let me let me kind of show you
I've got these examples here so on this
first one this is the good guy no tax so
the basis at the beginning of the year
let's say this was like year three the
basis of the beginning of the year is
forty one thousand and they made net
profit on the tax return of twenty
thousand this is simplified a little bit
because we probably would need to reduce
their basis for the 50 percent meals
that wasn't deductible that kind of
thing but let's just say it all added up
there were no meals let's say an ending
stock basis ends up you add these two
things together because when you make
money you're actually adding to last
year's basis right then you have
distributions of twenty five thousand
which wouldn't be crazy right if they
made 20 grand they could distribute
twenty five thousand because maybe
they've got some cash in the bank from
prior years or something like that and
their basis after the distributions 36
grand still this is good this is a year
where you don't have to really worry
about it you have to track it still and
that's what Halon does but you don't
have a problem in this situation over on
the other side it's a little different
so and this is gonna give you your first
hint of where basis starts to go wrong
in it it starts to go wrong when
companies start losing money okay that's
when it really starts to get bad and and
I'll go over more of this here in a
second but here the basis is the same
the start basis is the same forty one
thousand and then we have a current year
loss so they lost money so the ending
stock basis before their distributions
was sixteen thousand then even though
they lost money they pulled another 25
grand out now we have a problem because
this runs the stock basis negative it
means the basis after the distributions
is zero remember it can never be
negative and the difference the amount
that would have been negative is a
capital gain that that shareholder has
to recognize on the nine thousand so not
you know they they did get to deduct the
losses for the year but they had to pay
capital gains on their distributions
that makes sense so this is bad right
now this is kind of a weird situation
and you need to be thinking through this
like wait why if they lost 25 grand
and they had $16,000 a basis left in the
how did they even pull $25,000 ah I'm
gonna I'm gonna show you here in a
second but that's a key like it's very
rare that these S corporations have
money that they can pull out that's a
that exceeds their basis and we'll talk
about that some more but you know the
the big point here is you have to have
basis or else distributions are gonna be
taxable right all right let me show you
the second one which is when a company
runs a loss that they can't take so let
me pull that one up so in in this
example this is what we call suspended
losses the loss that the business had
gets partially suspended and carried
forward okay
the business starts with only $10,000 a
basis but then has that loss of
twenty-five thousand there's not enough
basis to offset that whole loss so the
shareholder gets to report ten thousand
of that loss as loss because that's how
much basis was left over and the rest of
that lost the fifteen thousand dollar
loss is what we call suspended and it's
carried forward into future years when
you have basis so you know how would
this person be able to actually
recognize the full twenty five thousand
they probably need to put fifteen grand
back into their business or something
right to where their basis goes back up
and they can recognize the whole twenty
five thousand but again I'm gonna show
you here in a second kind of how these
companies get to where they can
distribute cash that's in excess of all
of their bases these the suspended
losses and the the distribution tax are
kind of the two bad guys that if you're
not watching basis and this is what my
folks are watching for if they see
something that looks like this we're
gonna dive into a more insane hmm I
wonder if there's a you know a basis
problem here to make it a little more
complicated let me show you that there's
actually not just one there's two kinds
of basis okay and most of what you hear
about are it involves stock basis okay
that's what we've just been
using his stock basis but that's only
one part of the puzzle there's also
something called debt basis this is when
the shareholder makes a direct loan to
the business that shareholder loans the
business money that makes sense when
that happens their debt basis increases
and when the company pays the
shareholder back like pays the loan back
off the debt basis decreases the total
of stock basis and debt basis is really
what you have to watch ok so if they're
lending money to the company that
increases their basis you kind of add up
the stock basis and the debt basis and
that's the number you really got to make
sure doesn't get negative or else you're
gonna have these taxable events if if
you if you had a corporation that ended
up having debt basis that kind of made
up for their for their zero stock basis
and then the company pays the debt off
you know this is kind of where debt
basis gets weird if let's say the stock
basis was already zero and then they
lent the company money
$20,000 great and you know now they have
basis again but then after they had
taken a distribution of 20,000 they pay
the company pays the debt off well now
that debt payment is taxable so there's
no way around this basis thing even if
you loan money the company you can't
then have the company pay you back and
again the question should be on your
mind well how would the company be able
to pay the debt off if it had zero basis
and where does it get the money and all
of that kind of thing and you know by
now I'm sure you know your heads kind of
spinning basis basis basis let me let me
kind of show you some of these these
situations where companies really get
into a problem here and you'll start to
go ah I see what the I kind of see what
the trigger point here is so 99 percent
as I've said of my clients don't have a
basis issue and probably never will this
is because there is one thing one thing
that will create a situation more than
any other that has to be watched very
closely
it is a very common trigger for basis
issues and here it is the business takes
out a loan and that loan is in the form
of cash so if a business takes out a
loan against a car or something like
that you may not have an issue like this
because they're not getting cash that's
they can't really distribute that cash
out but when a company takes out let's
say a twenty thousand dollar loan it
gets a note in receipt you know the
signs a promissory note and they just
get cash that they slam in the bank
account what could they do with all that
cash if they wanted to they could
distribute it right they could
distribute it and even if the
shareholder guarantees that loan courts
have said it does not count as basis
that come if the loan is in the
company's name that is a as a company
loan and if they distribute that money
you better have enough basis to do it
because if you don't it's gonna be
taxable so what's the trigger event the
real the real trigger event is these
loans let me take you through these
examples I've got here so get my laser
pointer back out here's the the first
one basis at the start of the year they
have a current year loss so they that's
the first year and right out of the gate
they lose money 25 grand now in order to
lose $25,000 what would you have to do
you'd have to put $25,000 into the
company unless you're borrowing money if
you're not doing any loans the only way
to get a 25 thousand dollar loss is to
put twenty five thousand dollars of
something into the company at least you
might you might have put more that means
that at the end of the day you have a
twenty five thousand dollar loss but you
put money in of twenty five thousand
dollars so you're ending stock basis is
zero now if you put 25 grand into a
business and you lose it all is there
any money left over to distribute no so
your distributions are going to be zero
two basis after distributions as zeros
your capital gains this all is fine this
scenario right here is just fine and how
it happens a lot of times you know they
can't distribute more money than they've
got or that they put into these things
right let's go over to this other one
basis of zero starting out
made income the first year that's great
and they put 25 grand in at some point
right so they're ending stock basis is
$40,000 the income they made plus what
they put in if they want to pull all of
it back out right they made 15 grand
plus they put in 25 grand all of that
could be sitting in cash right at the
end of the year of $40,000 and they
decide to pull all of it out they want
everything out of the business retained
earnings would be zero all that right
still that's okay because the basis
after the distribution didn't go
negative so there's no capital gain or
anything here so the this situation is
fine here's where it gets goofy basis at
the beginning of the year zero current
year income fifteen thousand they put in
twenty five thousand ending stock basis
is forty grand right the company takes
out a loan from my cash advance or
something you know gets twenty thousand
dollars in exchange for a promissory
note they slam that into the bank
account so now they got sixty grand in
the bank account right because they took
this note and they they had they made
fifteen grand plus they had to cash that
the the owner put in or the value at
least if the owner put in so they've got
the 40 plus the twenty thousand they got
sixty grand in there so they this person
distributes fifty of it at the end of
the year whoops
because their basis was only 40 grand
this 20 grand did not increase it this
20 grand did not increase it now how
could they have done this they could
have taken out a personal loan right
that had nothing to do with the company
and then put the money into the business
and then pulled it all back out and that
would have been fine because when they
put the money in the instead of capital
contributions of 25 it would have had
this - and they would had capital
contributions of 45 but when you put
that loan in the business's name the
basis doesn't go up the distributions
you basically distributed part of the
company's money to you and the IRS says
nope you have taxable income now if ten
grand the difference between what your
basis was and the distribution does that
make sense this is the situation you
want to watch out for if you've got
clients that are borrowing money for
cash putting it in the business and then
you know doing lots of distributions and
things like that with it you more than
likely could easily end up with a
bassist situation what's another way
that bassist what's an easy way
sometimes not all the time but sometimes
to see if bassist might be an issue
that's looking at retained earnings
right because if they end up with more
liabilities than they have assets that
means they've taken on some kind of
liability and distributed it out
somewhere now retained earnings you
can't just look at retained earnings you
gotta look at capital contributions you
got to look at all that shareholder
distributions the whole equity section
but if your whole equity section is
negative you easily could have a basis
problem there because it may and that's
what my team gals and guys are going to
be looking for too so that's the real
danger zone so and if you get clients
like this just make sure you get us
involved conned you know and when I say
get us involved I mean hit the customer
service button chat pops up say hey I
think I've got a client that may have a
basis issue and I need to talk to one of
the CPAs you know as part of the CPA tax
team you know I need to talk to somebody
about it and we're going to route you to
someone to talk to you about it take a
look at everything and figure out if we
do have a situation like that get ahead
of it if you can if not no big deal
we're gonna look at it during tax time
and by the time here's the problem with
looking at it during tax time the years
over right so now there's nothing that
can be done that you can't go back and
put money in because most of the time
that's that's kind of a way to fix basis
is take some honey and put it back in
before the the year ends that away your
basis gets jacked back up and you don't
have these issues so that's why you guys
are on the front lines trying to try to
watch basis here that is all of it not
too long of a of a video I know I only
have one action note and it's this right
and I don't mean I'm a little
tongue-in-cheek here but I don't mean to
be but it really this is what I need you
to be doing watch the basis when
companies take out cash loans right when
you see companies that are in your
portfolio doing this put an eye on them
and and watch them and if it's looking
like by the end of the year they've got
some negative basis you need to let them
know let us know and we'll try and help
them make sure that they don't have a
you know some kind of taxable event so
that's it shareholder basis in a
nutshell there's a lot more to it I'm
here to tell you there's a lot more to
it and if you want to research it on
your own I would absolutely encourage
that but for now I have much more to
show you in this accounting 2 module so
I'll see you over in the next lesson and
thanks for watching