S Corporation Shareholder Basis and Loss Limitation
Marta owns 100% of a calendar-year S corporation. At the start of 2025 her stock basis is $40,000. She personally loaned the corporation $25,000 in 2023, documented by a promissory note; the corporation has not repaid it. In 2025 the corporation incurs an ordinary business loss of $80,000. Marta also received a $10,000 distribution in 2025 when the corporation had accumulated earnings and profits from prior C years. She asks how much of the loss she can deduct, whether the distribution is taxable, and what happens to the disallowed loss.
1. How much of the $80,000 loss can Marta deduct in 2025, and in what order are basis adjustments applied?
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Marta's deductible loss is limited to her stock basis plus her basis in any indebtedness owed to her by the corporation. Start: stock basis $40,000. The $25,000 loan gives her debt basis of $25,000 (a bona fide loan to the corporation, not a third-party guarantee). Total basis available = $65,000. However, the $10,000 distribution must be accounted for first. Because the corporation has accumulated E&P, the distribution is tested under the S corporation distribution rules: distributions are tax-free to the extent of stock basis (AAA ordering), reducing stock basis. Assuming the distribution reduces stock basis by $10,000 (to $30,000), then total basis = $30,000 stock + $25,000 debt = $55,000. The $80,000 loss is deductible only to $55,000. Order: (1) increase basis for income, (2) decrease for distributions, (3) decrease for losses-losses cannot reduce basis below zero.
2. What happens to the $25,000 disallowed loss, and how does the debt basis interact if the loss is later allowed?
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The $25,000 disallowed loss is suspended and carried forward indefinitely; it can be deducted in a later year when Marta has sufficient basis (e.g., from future income or additional capital contributions/loans). The loss first reduces stock basis to zero, then reduces debt basis; if debt basis is reduced, future repayments of the loan can trigger gain to the extent debt basis was reduced below the loan's face amount. Here, because stock basis is $30,000 and debt basis $25,000, the $55,000 allowed loss wipes out stock basis entirely and reduces debt basis to zero, leaving $25,000 suspended. Marta should document the loan and track debt basis separately; a later repayment of the $25,000 loan would produce gain to the extent basis was reduced (here, $25,000 of gain if fully repaid, since debt basis is zero).