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Dr. Fiona Chen
Dr. Fiona Chen, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 378
Experience:  Former IRS Revenue Agent
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AFTER CALCULATING SHAREHOLDER BASIS, HOW CAN I KNOW IF I CAN

Customer Question

AFTER CALCULATING SHAREHOLDER BASIS, HOW CAN I KNOW IF I CAN TAKE OR NOT THE LOSS FROM A K1?
JA: The Accountant will know how to help. Please tell me more, so we can help you best.
Customer: WHAT ELSE DO YOU NEED TO KNOW?
JA: Is there anything else important you think the Accountant should know?
Customer: NO
Submitted: 4 months ago.
Category: Tax
Expert:  Dr. Fiona Chen replied 4 months ago.

Dear Customer,

1) It seems that you received a K-1. It is mostly likely that you are interested in finding out whether you can take the K-1 loss on your personal tax return. You are probably reviewing a K-1 from a Form 1120S issued by an S Corporation.

2) Enclosed is a description of S-Corporation owners' basis and loss allowed. Enclosed is the most up to date IRS publication on shareholder's debt and stock share basis. This reference from the IRS website can help us understand the detailed process and basis of taking S Corporation losses. https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-stock-and-debt-basis

3) Please feel free to follow up.

Regards,

Fiona Chen, MPA, Ph.D., CPA, ABV, CFF, CITP

Customer: replied 4 months ago.
let me be more specific. and make worth my $39K1 has a loss of $104 668
cash contributed to capital is $ 135.092
no distributions
no non deductible itemsmy basis at the year end will be 30.424What else do you need to know to tell me if I can take the loss on personal return?
Expert:  Dr. Fiona Chen replied 4 months ago.

Dear Customer,

1) Is this your K-1 or your client's K-1? Are you an accountant? This answer can help me know how to relate information to you.

2) Where on K-1 does this loss show?

3) What type of business is this K-1?

4) Do you actively participate in the operating of the business?

5) Or is this company traded publicly?

6) How many percentage the shares show as the beginning of the year versus the end of the year on the book and on the K-1?

7) Why your basis is so low and how did you calculate it?

Regards,

Fiona

Customer: replied 4 months ago.
Well I am not sure if the basis is calculated correctly, so lets start from there.
cash contributed to capital is $ 135.092
income of the company is $ -104.668 ant that is it. no distributions made, no item of deduction.
my client has 100% of ownership in the company and is its first year
K1 shows $-104.668 reported on line 1 part 3 of K1 (ordinary business income/loss)
I am the bookkeeper and tax preparer. not a CPA
Customer: replied 4 months ago.
this is a restaurant
Expert:  Dr. Fiona Chen replied 4 months ago.

Dear Customer,

1) Does the owner issued a W-2 wage to him/herself? If yes, how much is it?

2) How much is the gross receipt of the Form 1120?

3) Has the business borrowed any money from anyone, including line of credit?

4) Is there any loan from and to the shareholder?

5) Has the restaurant taken out any credit cards to pay for its expenses?

6) Has the owner used his/her credit card for the business expenses?

7) So far, does the book shows any debt such as payroll liabilities not paid?

8) I have a question, for a corporation, the capital contribution is relatively large. Usually, during incorporation, the owner probably puts in like 1,000 cash as capital and everything else as loan to the company. I am not saying this way is correct or not. It is just a common way for capital contribution. Why is his cash contribution to the capital account is so large? Did he have an initial stock and later, additional capital contribution?

9) Are we talking about 2015 or 2016? If you have a K-1 already, I am thinking that it is a 2015 K-1.

10) Has he consulted with you or an attorney on whether the entire 135,092 he wants it to be capital contribution.

Regards,

Fiona

Customer: replied 4 months ago.
Dear Customer,1) Does the owner issued a W-2 wage to him/herself? If yes, how much is it?
No w2 for owner
2) How much is the gross receipt of the Form 1120?
220,253.23
3) Has the business borrowed any money from anyone, including line of credit?
no lines of credit
4) Is there any loan from and to the shareholder?
all the money contributed to investment is on the capital account, didn't do it as a loan from owner
5) Has the restaurant taken out any credit cards to pay for its expenses?
no lines of credit
6) Has the owner used his/her credit card for the business expenses?
no credit cards at all,
7) So far, does the book shows any debt such as payroll liabilities not paid?
I do have $5542 in payroll liabilities which I don't understand why, we paid all payroll taxes quarterly. I am reviewing payments to see where is the error.
8) I have a question, for a corporation, the capital contribution is relatively large. Usually, during incorporation, the owner probably puts in like 1,000 cash as capital and everything else as loan to the company. I am not saying this way is correct or not. It is just a common way for capital contribution. Why is his cash contribution to the capital account is so large? Did he have an initial stock and later, additional capital contribution?
When I meant cash it doesn't mean necessarily that all the expenses where paid in cash, most of them where from his personal bank account. but all of them where part of the initial investment for the restaurant, which I didn't categorized it as a loan from the owner . I just did it as a capital stock thinking that eventually all that money invested has to be paid back to the owner. Lack of knowledge.9) Are we talking about 2015 or 2016? If you have a K-1 already, I am thinking that it is a 2015 K-1.
this K1 is for 2014, 2015 has a loss as well , business was closed at the beginning of 2016 no more contributions made on 2015, no distributions ether.10) Has he consulted with you or an attorney on whether the entire 135,092 he wants it to be capital contribution.
None of the above, I am the one who recorded all this expenses as a capital contribution.Regards,Yasmin
Expert:  Dr. Fiona Chen replied 4 months ago.

Dear Customer,

The taxpayer will have late filing penalty for the S Corporation.

In a way, it is good that the restaurant is closed. The way the business was going, he is paying his customer $1 for every $2 food they consumed.

If the picture is this straight, he should have basis to take the entire loss on his return for 2014.

The IRS has this concern about S corporation owners lacking basis to take loss. That is only one court case they have won. However, usually, a small business should not have issue in the owner's personal return to take the loss. In a small business, there is no source for funding other than the owner. Therefore, everything will and should add up the same. If the company has loss, there must be a source to pay for the loss and that is usually the owner. Most of the times, they are purchases or payment on credit cards. Small business has no credit cards other than the ones that the owner takes out. Usually, the business name is ***** ***** card, but the owner actually has his/her SSN on file to qualify the card and guarantee the card. Therefore, the card actually is directly taken out by the owner.

So, in 2015, you want to watch out for the basis. If he does not owe anyone, and there is a business loss which he does not have basis to take on his person return. Look into the possibility that there could be a short reported income. In that case, I am not saying it it the case with your client, the way the IRS stopping the loss taken for lacking basis makes sense. This method adjusts the short reported income issue on the owner's tax return.

Regards,

Fiona

Customer: replied 4 months ago.
The Corporate and personal return has been filed already, its under review by the IRS. The auditor request basis shareholder report. that's why I had all this questions. So for future reference all money invested by the owners will be better reported as a loan to the company and not as a capital stock?
Expert:  Dr. Fiona Chen replied 4 months ago.

Dear Customer,

The tax returns do not seem to be under IRS review; they are being examined and audited. Be aware and be alert. You probably want to read through the S corporation basis I shared in the previous two postings and understand where the auditor comes from. Fully document and show with evidence to prove the basis.

For future reference, the stock and loan issue.

It needs to be well designed and thought through. There is initial capital account. That is the part with attorney to set up the company.

The loan needs to be bona fide and is better to sign an agreement with the shareholder. It can be an open credit line borrowed from shareholder.

Additional paid in capital is fine; but it needs to be bona fide, as well. Usually, additional capital is paid in when the company has a business plan to expand, etc. It is often used when there are multiple owners.

Loan in and out is more flexible on accounting and bookkeeping and is more reflecting the reality.

There is another issue here, the loan has a higher priority in recovery from the company than equity if there is any bankruptcy or liability lawsuit issue. That is why when we put money into equity, we need to think twice.

LLC does not have capital stock; it has percentage or unit of membership. If this is a corporation, try to consider C corporation, Form 1120, filing next time. After this time of the S corporation audit by the IRS, you will understand what I mean. There are too many aspects of an S corporation can cause red flag. It does not related to itself; it caused the 1040 to be opened, as well.

Regards,

Fiona