It is important to determine a shareholder’s S Corporation (S Corp) basis to properly deduct losses on his/her individual tax return. Losses allowed on an individual’s tax return cannot exceed the owner’s basis in the S Corp. Basis is determined primarily by the original purchase price of the shares and the addition of shareholder contributions and accumulated net earnings, less non-dividend distributions and accumulated net losses.
A shareholder can also increase basis through use of debt. A loan made to the S Corp from the shareholder increases the basis, thereby increasing the ability to deduct S Corp losses on the individual tax return. However, there must be an actual obligation for the S Corp to repay the loan to the shareholder (or the shareholder to repay the loan to the bank for proceeds loaned to the S Corp) to increase the basis. Merely co-signing a loan or providing a guarantee on behalf of the S Corp does not qualify to increase basis in the S Corp. The shareholder must be the debtor on the loan (liable to the bank) that provides the proceeds as a loan to the S Corp.