When you own an S corporation, the company's gains are your gains and its losses are your losses. All the income and expense are passed through to the company's shareholders. But the IRS limits the amount that you can claim as a loss to your basis in the stock, plus any outstanding loans directly from you to the corporation.
Strategy: Make a capital contribution or a loan to the company. That will increase your basis to provide more "breathing room" to absorb losses.
To determine how much you should contribute, take a quick look at where you stand midyear.
Key point: To boost your basis, the money must come out of your own pocket. For instance, you can't jigger your tax losses by arranging a loan to the S corporation from a third party (such as a bank or a neighbor). The IRS and the courts have consistently denied loss deductions for third-party loans.
Case in point: A taxpayer was the sole S corporation shareholder involved in the propane industry. After wiping out his basis with a series of tax losses, he arranged for the corporation to take out a $4 million bank loan. The taxpayer argued that he should be able to claim losses up to the bank loan amount. Reason: He had personally guaranteed the loan and effectively "lost control" of the corporation to the lender because he pledged stock as collateral.
But the Tax Court didn't buy those arguments. It denied the taxpayer a deduction for the losses in excess of the basis and refused to give the shareholder any extra basis from the corporation's borrowing. (Maloof, TC Memo 2005-75)
Advice: On the flip side, tax losses may be more valuable to you in the future when you expect higher income. Any nondeductible losses can be carried forward indefinitely until you have sufficient basis to absorb them.
Hold off on making capital contributions or loans if you don't need losses this year. Keep your money in your own pocket for as long as you can.
- Small Business Tax Deduction Strategies No matches