Trap 10 · The basis · From Chapter 9
Stock and Debt Basis: What Lets Losses Through
Stock and debt basis is the shareholder's investment measure that gates S-corp loss deductions — losses pass through only to the extent of basis under §1366(d), with stock basis absorbed first and debt basis second.
The limit
Section 1366(d) caps the shareholder's pass-through losses and deductions at combined stock and debt basis. Income can pass through without basis; losses cannot — the excess suspends and carries forward until basis is restored.
Stock first, then debt
Ordering matters: stock basis is reduced before debt basis, and restored in the same order. Only direct loans from the shareholder to the corporation create debt basis — guaranteeing the corporation's bank loan does not. Basis is only half the story: the salary itself must be defensible, as reasonable compensation explains, and every distribution vs salary choice moves basis too.
Open-account debt
Shareholders who advance and withdraw funds repeatedly can treat the running balance as open-account debt rather than documenting each advance as a separate note — advances and repayments net into one balance that adjusts basis. Keep a clean ledger: commingled personal charges turn the account into an audit exhibit.
Trap questions, answered
- Can a shareholder deduct losses above stock basis?
- Yes, to the extent of debt basis from direct loans to the corporation. Guaranteeing a corporate loan does not create basis.
- What is open-account debt?
- A running balance of advances and repayments between shareholder and corporation that adjusts basis without a separate note for each advance.
- What happens to losses blocked by missing basis?
- They suspend and carry forward, allowed in a later year when the shareholder restores stock or debt basis.
The law: 26 U.S.C. §1366 · §1367 · Full Ch. 9 summary
The other traps: Distributions vs Salary · Reasonable Compensation · AAA and Excess Distributions · Built-In Gains Tax