Shareholder Basis and operating loss

[SunTaxMan]

2 Shareholders, 50/50, in S-Corp. Operating Loss this year. K-1 shows ordinary loss.

Shareholders have invested NO money in the business and this is the first year of operation. The business has been funded by commercial loan with shareholders' personal residence as collateral on the loan. I calculate this to mean shareholders have no basis - they have not invested any personal money or property in the business and there has been no profit.

I interpret this to mean the loss on the K-1 cannot be deducted - cannot be used to offset income from other sources (W-2), i.e., loss is carried over to future year(s).

One shareholder is active in the business the other is passive (home collateral only).

ATX is carrying loss on K-1 to 1040. I don't think it should, because (1) active shareholder has no basis, (2) passive shareholder has no basis nor any passive income.

Second question - ((Even if passive shareholder DID have other passive income, the absence of shareholder basis in the S-Corp would prevent the S-Corp passive loss from being considered on the 1040. Correct?))

What am I missing?

[kcjenkins]

I disagree with your statement that they have no basis. The person who borrowed the money on his house, [or their house if this is a couple, a detail that is not clear] and then put that money into the business has basis in the business equal to the funds invested. The SCorp did not own the home, so it could not borrow money on it. So clearly, the owner of the house borrowed the money, even if they immediately put it into the business.

Also, the K-1 always sends the loss to the stockholders, where it is determined whether THEY have basis to deduct it now, or have to carry it over. The S Corp does not necessarily know whether it can be used now or not, but that does not affect anything on the Corp books. It's still passed through, each year. You have to properly enter the info into the 1040 to let the software know whether to take the loss now or carry it over.

[SunTaxMan]

KC,

To clarify.....

You said, "I disagree with your statement that they have no basis. The person who borrowed the money on his house, [or their house if this is a couple, a detail that is not clear] and then put that money into the business has basis in the business equal to the funds invested. The SCorp did not own the home, so it could not borrow money on it. So clearly, the owner of the house borrowed the money, even if they immediately put it into the business. "

The "loan" is a Commercial Loan, with the business name as the borrower, with the business FEIN as the identifier on the loan. No 1098 is issued. The collateral for the loan is the residence/real estate of these two shareholders (by the way, two separately owned residences, not that it matters). A thread sometime ago led to the conclusion that because of these facts, the loan did not establish basis, i.e., the shareholders did not borrow the money, the business did. Proceeds of the loan were never paid to the shareholders, but to the business. Shareholders did not write any checks payable to the business for loan proceeds - the bank wrote the loan proceeds payable to the business - the simple use of the residence/real estate as collateral does not establish basis. I conclude this "small town bank" did not handle this loan in the best interests of these taxpayers, BUT, (1) it is DONE and (2) they didn't ask me before consumating the loan process.

Is this incorrect?

You also said, "Also, the K-1 always sends the loss to the stockholders, where it is determined whether THEY have basis to deduct it now, or have to carry it over. The S Corp does not necessarily know whether it can be used now or not, but that does not affect anything on the Corp books. It's still passed through, each year. You have to properly enter the info into the 1040 to let the software know whether to take the loss now or carry it over."

I have reviewed the 1040, Schedule E, and the K-1 (1120S) Input Worksheet (in the 1040 file) in my ATX - and I can find no reference to, nor dealing with, shareholder basis. So, I assume if the K-1 from the 1120S shows a loss on line 1, it would naturally carry to Schedule E as a loss, and therefore page 1 of the 1040.

I have reviewed the 1120S, and the K-1 input sheet in the 1120S file. Shareholder basis IS dealt with in the 1120S in ATX. And:

1. In the 1120S form and worksheets, I find nothing about shareholder basis.

2. In the 1120s, K-1, I find the loss entered (as a negative figure) on Line 1, Ordinary Income or Loss. HOWEVER, on the "Shareholder's Basis Statement," worksheet as part of the 1120S, K-1 (IN the 1040 program - there is NO such "Shareholder's Basis Statement" or related worksheet - perhaps there should be), I find zeros on every line dealing with "Stock Basis," "Loan Balance," "Loan Basis," and "Total Basis." On the line for "Loss Carryovers," Line 1, "Loss items carried over to next year" is the identical loss amount from line one of the K-1 --- I interpret this to mean the S-Corp does know the loss is not currently deductible because of shareholder basis limitation. This "Shareholder's Basis Statement" is clearly marked, "Note to Shareholder - keep for your records." Down further on this "Shareholder's Basis Statement" is a section titled, "Part VIII - Loss and Expense Items," where "Ordinary loss from trade or business activities" carries the same loss amount (as a positive figure).

My dilemma - IF the loss on the K-1, line 1 is NOT deductible this year, BECAUSE of no basis (which is correct. Correct?) then the negative amount on line 1 of the K-1 is inappropriate. The presence of the "loss carryover" on the "Shareholder's Basis Statement" SHOULD prevent the loss amount from appearing on line one of the K-1. If I enter the K-1 loss on the 1040 1120S K-1 worksheet, there is no mechanism in the ATX program to prevent this loss from appearing on Schedule E ( at least, I have not found some "option" to "check off" that would produce the correct handling.). There is no section of this 1120S K-1 worksheet in the 1040 file that deals with shareholder basis. It would appear that the advisement to "carry this amount to next year" SHOULD have prevented the amount from appearing as a loss for this year on line 1).

At this point, I CAN:

1. NOT put the line one loss from the K-1 on the 1040 1120S K-1 worksheet, which would not be a "normal" entering of K-1 information into the 1040, or,

2. Enter the K-1, as is, and then override the Schedule E, page 2 entry to zero (based on the {1} "Shareholder Basis Statement" and {2} absence of shareholder basis) BUT, I always hesitate to override the software unless I am absolutely positive that the program is not handling the situation correctly and no unseen consequences will occur.

I do appreciate your thoughts and feedback.

An afterthought --- I can understand, in the situation of passive loss (with adequate basis to make the loss otherwise deductible), (1) the S-Corp would NOT have access to information about any other passive losses or income that this shareholder might have, to be able to determine if the loss was deductible this year and, (2) the deductibility of the loss WOULD be determined at the shareholder level ----- but the absence of basis would prevent this consideration from even coming into thinking because the loss is NOT deductible - no basis - at this point, the loss should STAY within the S-Corp and be shown on next year's K-1, as a current loss, IF there is basis next year, OR as an increased carryover to the next year following, if there is still no basis.

Am I missing something?

Should I simply override the program, eliminate the loss deduction and get on with more productive work?

[kcjenkins]

OK, so they managed to totally screw up on the loan, and the banker is an idiot, too. So no basis at this time. Wow, I can't imagine how that happened, but I believe you. Still, with an S Corp, the loss does not stay in the corp, it still passes through. That is the nature of the S Corp.

What I think you must have missed was adding a 6198 to the return, to set up the suspension of the loss. Or, in this case, since it is so clearcut, you could just drop down to the bottom of the 1120S K-1 input sheet, and put zero in the line for 'allowed losses from Form 6198. What you should NOT do, IMHO, is to override the income line. You want to put in the loss, then show that it is suspended, so that when you finally get their financial affairs straightened out to the point that they DO have basis, it is clear where it is coming from.

[SunTaxMan]

Much thanks,

And to think that I have been under the impression, at least for the last year or so, that nothing good could EVER come from Arkansas!

I am proven wrong again!

[kcjenkins]

Hey, Arkansas is a very nice state, just cursed with lousy politicians, is all. I'm convinced that comes from the fact that it is really a one-party state, so the bums seldom get cleaned out. Even when a good one gets in, he or she is 'guided' to not let out the party dirty laundry in public, so the bad ones just get more and more power.

That is why in one way, Bill did us a favor. His misdeeds led to a lot of local pols getting exposed, and some even sent to prison. Shining bright lights into the corners, under the couches, and in the closets and attics is a good thing, from time to time. Maybe someday we will actually get to the point of having two parties in this state, at least I hope so. Although the Huskster set us back on that goal, quite a bit.

[Randall]

I know you can use the Form 6198 to make it work in ATX. But I didn't think Form 6198 was really for basis limitations. I always understood there were three things to determine loss deductibility, basis limitation, at risk limitation and passive loss limitation.

I've always inputed zero on the 1040 K-1 input sheet for ordinary income/loss when there was basis limitation. From some PPC references I have, zero is shown on Sch E and a statement is attached showing the K-1 loss and basis limitation and the amount of the loss to carry forward to next year. This is how I've done it in the past with paper returns. In recent years with more efiling, I've included that 'statement' in the preparers notes section of the efile info so it would 'hopefully' go with the efiled info. If income is shown in a future year on the K-1, I input that year's income on the 1040 K-1 input sheet, make a 2nd column for the same company and input the loss carried forward with the 'Prior Year Loss' description. This makes the proper netting flow thru to the Sch E and shows it on a separate line.

I think this is an area where ATX doesn't handle it correctly and like others have said, you can use 6198 and the bottom of the 1040 K-1 input sheet to make it work inputing the loss on the K-1 worksheet and having zero flow thru to Sch E. But I wonder is this is technically correct?

[SunTaxMan]

On another tax board, in response to this discussion, the thought has been expressed that this could be,

"collateral on the guarantee, rather than on the loan."

Why would/could this be significant to me? Could it affect shareholder basis in the S-Corp?

Anyone have any insight? Thanks.

[RoyDaleOne]

"collateral on the guarantee, rather than on the loan."

If the loan had been in the personal names that could have made a different. Because the loan, as pointed out, was in the "business name" there is no increase in basis because of shareholders' loans.