If you’re new to our blog series, first off, welcome! We typically post various news and tidbits related to tax laws and how they may impact you and/or your business. Maybe you’ve heard, but recently there was a sweeping change to the U.S. Tax Code – the largest change in over 30 years actually. We blogged non-stop about the various changes over the winter and spring (check the archives – there’s some very useful info in there!), but there is one small change that we didn’t touch on related to small business losses – tax basis.
Generally, a partner or shareholder of an S Corporation may not deduct any losses that exceed their basis in the entity. Basis is just tax mumbo jumbo for one’s ownership in a company. That is, your ownership stake in your business is the money you put into the company, plus any income you’ve made, less any losses you’ve incurred and any money you’ve taken back out of the business (an owner’s draw), with a few other exceptions. It’s a calculation done each year and is vital for many reasons.
One of the key reasons it’s important to track basis is because losses in excess of basis are suspended, or not deductible, until you have enough basis to take them. For example, if my basis is $4,000 and my company loses $10,000 this year, I can only take $4,000 of losses (the extent of my basis) – the remaining $6,000 is suspended until the next year. If I make $10,000 in income next year, I offset $6,000 of that income with my prior year suspended losses. It makes sense – you shouldn’t be able to deduct losses if you have no skin in the game, so to speak.
The change I referred to above has to do with the definition of “losses” and what items are specifically classified as losses as it relates to basis calculations. Under the old law, charitable donations and foreign tax credits that flowed to a shareholder or partner were not subject to the basis limitation. Even if you had no basis, you could still deduct charitable donations made by your company and take foreign tax credits on foreign income. Under the new law, these items are now included in the definition of losses. Thus, you and your accountant will need to keep schedules and determine if some of your charitable contributions and foreign tax credits will be suspended, just like regular losses.
If you picked up anything from this blog, I hope it is the knowledge that tracking your basis in pass-through entities is critical for several reasons, including the change above. Check with your CPA if they are tracking basis in your entities and if not, it might be a good idea to start!
Brock R. Yates, CPA, MT