IRS Code Section 1367

Definition

IRS Code Section 1367 provides guidelines for determining the basis of shareholders in S corporations, particularly focusing on the adjustments to the basis of their stock and debt. This section is essential for understanding how distributions to shareholders are treated and how they affect a shareholder's tax position, especially regarding limitations on loss deductions and distributions from the corporation.

5 Must Know Facts For Your Next Test

1. Section 1367 allows shareholders to increase their basis by the amount of income earned by the S corporation, which can include both ordinary income and separately stated items.
2. Shareholders must decrease their basis by any distributions received from the S corporation, which can lead to potential gain recognition if the distribution exceeds their adjusted basis.
3. Losses that an S corporation incurs can only be deducted by shareholders up to their basis in the corporation, so understanding Section 1367 is crucial for tax planning.
4. Any debt that a shareholder has personally guaranteed can also increase their basis, allowing them to take larger losses against their personal tax liability.
5. If a shareholder's basis is reduced to zero, any further losses cannot be deducted until additional basis is restored, making tracking adjustments essential.

Review Questions

• How does IRS Code Section 1367 impact a shareholder's ability to deduct losses from an S corporation?
  • IRS Code Section 1367 impacts a shareholder's ability to deduct losses by limiting those deductions to the shareholder's adjusted basis in the S corporation. Shareholders must keep track of their basis since losses can only be deducted up to this amount. If the losses exceed the shareholder's basis, the excess cannot be utilized until the basis is increased through income or additional contributions.
• Discuss how distributions from an S corporation affect a shareholder's basis as per Section 1367.
  • Distributions from an S corporation directly reduce a shareholder's basis according to IRS Code Section 1367. When a distribution is received, it decreases the adjusted basis in the shareholder's stock. If distributions exceed the shareholder’s basis at that time, the excess amount is treated as capital gain. Therefore, understanding how these distributions work is crucial for proper tax planning and avoiding unexpected tax liabilities.
• Evaluate the significance of maintaining accurate records of basis adjustments under IRS Code Section 1367 for long-term shareholders in an S corporation.
  • Maintaining accurate records of basis adjustments under IRS Code Section 1367 is vital for long-term shareholders because it directly influences their tax obligations related to income, losses, and distributions. Without precise tracking of increases and decreases in basis, shareholders may face unexpected tax liabilities when they receive distributions or sell their shares. Moreover, accurate records ensure that they maximize potential loss deductions and minimize taxable gains, playing a crucial role in effective tax strategy and financial planning.

Related terms

Basis:

The amount of investment in property or stock that determines gain or loss for tax purposes.

S Corporation:

A special type of corporation that meets specific IRS requirements, allowing income, losses, and deductions to pass through to shareholders for federal tax purposes.

Distributions: Payments made by an S corporation to its shareholders, which can affect their basis and tax liability.