Business Entities · S corporations

Shareholder's basis

Verification 2026 Verified
tax year · reviewed 2026-08-21 · Draft for I. Ohu review

Basis is the account that decides two separate questions: whether a distribution is taxable and whether a loss is deductible. In subchapter S it comes in two forms — stock basis and debt basis — and the rules for creating debt basis are strict in a way that catches a great many people who believe they have put something at risk when they have not.

The rule

Increases. a shareholder's basis in S corporation stock is increased by the separately stated items of income described in IRC § 1366(a)(1)(A), by non-separately computed income under § 1366(a)(1)(B), and by the excess of depletion deductions over the basis of the property subject to depletion (IRC § 1367(a)(1))^TY2026 (IRC § 1367(a)(1)). Tax-exempt income increases basis; that is deliberate, and it is the difference between the basis account and the accumulated adjustments account.

Decreases. basis is decreased, but not below zero, by distributions not includible in income by reason of IRC § 1368, items of loss and deduction, non-separately computed loss, non-deductible expenses not chargeable to capital account, and the oil and gas depletion deduction^TY2026 (IRC § 1367(a)(2)). Note the floor: stock basis stops at zero.

The order. for a taxable year beginning on or after 18 August 1998: first the increases for income items and excess depletion; then the decrease for distributions; then the decrease for non-capital, non-deductible expenses and oil and gas depletion; and last the decrease for items of loss and deduction^TY2026 (Reg. § 1.1367-1(f)). Income first, then distributions, then non-deductible expenses, then losses — and a shareholder may elect to take losses and deductions before non-capital, non-deductible expenses, in which case any of those expenses exceeding the shareholder's basis in stock and indebtedness carries to the succeeding year; the election is made by a statement attached to a timely filed original or amended return and binds the shareholder for that corporation in future years without the Commissioner's permission to change^TY2026 (Reg. § 1.1367-1(g)).

Only income actually reported counts. an amount required to be included in a shareholder's gross income increases stock basis only to the extent it is included on the return, as increased or decreased by any adjustment on a redetermination of the shareholder's tax liability^TY2026 (IRC § 1367(b)(1)).

Charitable contributions of property. the decrease for a charitable contribution of property is the shareholder's pro rata share of the adjusted basis of the property, not its fair market value^TY2026 (IRC § 1367(a)(2), flush text).

The loss limitation. the aggregate losses and deductions taken into account for any taxable year cannot exceed the sum of the adjusted basis of the shareholder's stock and the adjusted basis of any indebtedness of the corporation to the shareholder^TY2026 (IRC § 1366(d)(1)). What is disallowed is not lost: a loss or deduction disallowed for want of basis is treated as incurred by the corporation in the succeeding taxable year with respect to that shareholder, indefinitely, and on a transfer of the stock between spouses or incident to divorce it moves to the transferee^TY2026 (IRC § 1366(d)(2)).

Debt basis. Once stock basis is exhausted, where the loss, deduction, non-deductible expense and depletion items exceed the amount that reduces stock basis to zero, the excess reduces, but not below zero, the shareholder's basis in any indebtedness of the corporation to the shareholder held at the close of the year^TY2026 (IRC § 1367(b)(2)(A)). And when the corporation recovers, a net increase in a subsequent year restores the reduction in the basis of the indebtedness before any of it may increase stock basis, and never above the adjusted basis of the indebtedness at the beginning of the year in which the net increase arises^TY2026 (IRC § 1367(b)(2)(B)).

What counts as debt. the shareholder's adjusted basis in any bona fide indebtedness of the S corporation that runs directly to the shareholder, determined under general federal tax principles on all the facts and circumstances^TY2026 (Reg. § 1.1366-2(a)(2)(i)) — and, decisively, a shareholder does not obtain basis of indebtedness merely by guaranteeing a loan or acting as surety, accommodation party or in any similar capacity; basis arises only to the extent the shareholder actually makes a payment on that indebtedness^TY2026 (Reg. § 1.1366-2(a)(2)(ii)).

Current figures

Item	Rule	Authority
Increases to stock basis	a shareholder's basis in S corporation stock is increased by the separately stated items of income described in IRC § 1366(a)(1)(A), by non-separately computed income under § 1366(a)(1)(B), and by the excess of depletion deductions over the basis of the property subject to depletion (IRC § 1367(a)(1))^TY2026	IRC § 1367(a)(1)
Decreases to stock basis	basis is decreased, but not below zero, by distributions not includible in income by reason of IRC § 1368, items of loss and deduction, non-separately computed loss, non-deductible expenses not chargeable to capital account, and the oil and gas depletion deduction^TY2026	IRC § 1367(a)(2)
Order of adjustments	for a taxable year beginning on or after 18 August 1998: first the increases for income items and excess depletion; then the decrease for distributions; then the decrease for non-capital, non-deductible expenses and oil and gas depletion; and last the decrease for items of loss and deduction^TY2026	Reg. § 1.1367-1(f)
Elective ordering	a shareholder may elect to take losses and deductions before non-capital, non-deductible expenses, in which case any of those expenses exceeding the shareholder's basis in stock and indebtedness carries to the succeeding year; the election is made by a statement attached to a timely filed original or amended return and binds the shareholder for that corporation in future years without the Commissioner's permission to change^TY2026	Reg. § 1.1367-1(g)
Income must be reported	an amount required to be included in a shareholder's gross income increases stock basis only to the extent it is included on the return, as increased or decreased by any adjustment on a redetermination of the shareholder's tax liability^TY2026	IRC § 1367(b)(1)
Charitable gift of property	the decrease for a charitable contribution of property is the shareholder's pro rata share of the adjusted basis of the property, not its fair market value^TY2026	IRC § 1367(a)(2), flush text
Charitable excess, loss limit	where the charitable contribution basis rule applies, the loss limitation does not apply to the excess of the shareholder's pro rata share of the contribution over their pro rata share of the adjusted basis of the property^TY2026	IRC § 1366(d)(4)
Loss limitation	the aggregate losses and deductions taken into account for any taxable year cannot exceed the sum of the adjusted basis of the shareholder's stock and the adjusted basis of any indebtedness of the corporation to the shareholder^TY2026	IRC § 1366(d)(1)
Disallowed loss carryover	a loss or deduction disallowed for want of basis is treated as incurred by the corporation in the succeeding taxable year with respect to that shareholder, indefinitely, and on a transfer of the stock between spouses or incident to divorce it moves to the transferee^TY2026	IRC § 1366(d)(2)
After termination	a loss disallowed in the corporation's last S year is treated as incurred by the shareholder on the last day of any post-termination transition period, limited to the adjusted basis of the stock at the close of that day and reducing that basis by the amount allowed^TY2026	IRC § 1366(d)(3)
Reduction of debt basis	where the loss, deduction, non-deductible expense and depletion items exceed the amount that reduces stock basis to zero, the excess reduces, but not below zero, the shareholder's basis in any indebtedness of the corporation to the shareholder held at the close of the year^TY2026	IRC § 1367(b)(2)(A)
Restoration of debt basis	a net increase in a subsequent year restores the reduction in the basis of the indebtedness before any of it may increase stock basis, and never above the adjusted basis of the indebtedness at the beginning of the year in which the net increase arises^TY2026	IRC § 1367(b)(2)(B)
Bona fide indebtedness	the shareholder's adjusted basis in any bona fide indebtedness of the S corporation that runs directly to the shareholder, determined under general federal tax principles on all the facts and circumstances^TY2026	Reg. § 1.1366-2(a)(2)(i)
Guarantees	a shareholder does not obtain basis of indebtedness merely by guaranteeing a loan or acting as surety, accommodation party or in any similar capacity; basis arises only to the extent the shareholder actually makes a payment on that indebtedness^TY2026	Reg. § 1.1366-2(a)(2)(ii)
Open account debt	$25,000 — shareholder advances not evidenced by a separate written instrument, and repayments on them, are open account debt treated as a single indebtedness so long as the aggregate outstanding principal does not exceed $25,000 at the close of the corporation's taxable year; above that, the balance is treated thereafter as debt evidenced by a written instrument^TY2026	Reg. § 1.1367-2(a)(2)
Stock taken for services	stock issued for services is included in the service provider's gross income under IRC § 83(a) at its fair market value less any amount paid, and that included amount is the shareholder's starting basis in the stock^TY2026	IRC § 83(a)
Inherited stock	basis determined under IRC § 1014 for S corporation stock is reduced by the portion of the value of the stock attributable to items constituting income in respect of a decedent, and IRC § 691 applies to the corporation's items as if the decedent had held their pro rata share directly^TY2026	IRC § 1367(a)(4), IRC § 1014

How it works in practice

Run the year in order. for a taxable year beginning on or after 18 August 1998: first the increases for income items and excess depletion; then the decrease for distributions; then the decrease for non-capital, non-deductible expenses and oil and gas depletion; and last the decrease for items of loss and deduction^TY2026 (Reg. § 1.1367-1(f)). The order is what makes a distribution tax-free in a loss year: the income comes in first, the distribution is measured next while basis is at its highest, and only then do the losses eat what is left. Reverse any two steps and both answers change.

Know why the elective ordering exists. a shareholder may elect to take losses and deductions before non-capital, non-deductible expenses, in which case any of those expenses exceeding the shareholder's basis in stock and indebtedness carries to the succeeding year; the election is made by a statement attached to a timely filed original or amended return and binds the shareholder for that corporation in future years without the Commissioner's permission to change^TY2026 (Reg. § 1.1367-1(g)). A non-deductible expense that runs out of basis is simply gone under the default order; take the losses first and the expense carries forward instead. The price is permanence — the shareholder must keep using the elected order for that corporation.

Two accounts, one limit. the aggregate losses and deductions taken into account for any taxable year cannot exceed the sum of the adjusted basis of the shareholder's stock and the adjusted basis of any indebtedness of the corporation to the shareholder^TY2026 (IRC § 1366(d)(1)). Losses reduce stock basis to zero first, and only the excess reaches debt basis. Distributions never touch debt basis: IRC § 1367(a)(2)(A) is a stock adjustment and there is no counterpart in IRC § 1367(b)(2)(A), which lists only the loss, deduction, expense and depletion items.

Debt must be the shareholder’s own. the shareholder's adjusted basis in any bona fide indebtedness of the S corporation that runs directly to the shareholder, determined under general federal tax principles on all the facts and circumstances^TY2026 (Reg. § 1.1366-2(a)(2)(i)) — “runs directly to the shareholder” is the operative phrase. A loan the corporation takes from a bank gives the shareholder nothing, however solid the shareholder’s credit behind it, and a shareholder does not obtain basis of indebtedness merely by guaranteeing a loan or acting as surety, accommodation party or in any similar capacity; basis arises only to the extent the shareholder actually makes a payment on that indebtedness^TY2026 (Reg. § 1.1366-2(a)(2)(ii)). The shareholder gets basis when they pay, not when they promise. Compare the partnership rule, where a partner’s share of partnership liabilities is treated as a contribution of money under IRC § 752(a) and does increase outside basis. That divergence is the single most consequential difference between the two regimes for a leveraged business.

Restoration runs before stock. a net increase in a subsequent year restores the reduction in the basis of the indebtedness before any of it may increase stock basis, and never above the adjusted basis of the indebtedness at the beginning of the year in which the net increase arises^TY2026 (IRC § 1367(b)(2)(B)). A profitable year repairs the loan account first. This matters because a repayment of a loan whose basis has been reduced is a recognition event — the shareholder has gain on the repayment to the extent the amount received exceeds the reduced basis of the debt.

Open account debt is a simplification, with a ceiling. $25,000 — shareholder advances not evidenced by a separate written instrument, and repayments on them, are open account debt treated as a single indebtedness so long as the aggregate outstanding principal does not exceed $25,000 at the close of the corporation's taxable year; above that, the balance is treated thereafter as debt evidenced by a written instrument^TY2026 (Reg. § 1.1367-2(a)(2)). Below the threshold, advances and repayments in a year are netted and treated as one debt, so a shareholder running a current account with the corporation is not computing gain on every repayment. Cross it at year end and the balance is treated thereafter as though it were a note.

Where basis starts. Stock bought is cost. stock issued for services is included in the service provider's gross income under IRC § 83(a) at its fair market value less any amount paid, and that included amount is the shareholder's starting basis in the stock^TY2026 (IRC § 83(a)) for stock taken for services — and note that the corporation’s deduction and the shareholder’s basis are the same figure. Stock contributed for property in a IRC § 351 exchange takes a substituted basis. basis determined under IRC § 1014 for S corporation stock is reduced by the portion of the value of the stock attributable to items constituting income in respect of a decedent, and IRC § 691 applies to the corporation's items as if the decedent had held their pro rata share directly^TY2026 (IRC § 1367(a)(4), IRC § 1014) — the step-up applies but is cut back for income in respect of a decedent, which has no counterpart in a C corporation and is a favourite of examiners.

The guarantee that bought nothing

Rowan Instrument Co. borrows $300,000 from a bank. Its sole shareholder personally guarantees the loan and pledges her house. The corporation loses $260,000 in the year. Her stock basis, after the year’s income adjustments, is $40,000.

She may deduct $40,000. The remaining $220,000 is disallowed by IRC § 1366(d)(1) and carried forward indefinitely under IRC § 1366(d)(2). The guarantee gives her no debt basis: a shareholder does not obtain basis of indebtedness merely by guaranteeing a loan or acting as surety, accommodation party or in any similar capacity; basis arises only to the extent the shareholder actually makes a payment on that indebtedness^TY2026. The loan runs from the bank to the corporation, not from her to the corporation, so it fails the “runs directly to the shareholder” test of Reg. § 1.1366-2(a)(2)(i).

Had she instead borrowed the $300,000 from the bank herself and lent it on to the corporation, she would have had $300,000 of debt basis and the whole loss would have been deductible. Her economic exposure is identical either way. The tax result is not.

Three years later she pays $80,000 to the bank under the guarantee. At that point Reg. § 1.1366-2(a)(2)(ii) gives her basis of indebtedness of $80,000, and $80,000 of the suspended loss becomes deductible.

Ordering, and a distribution in a loss year

Callender Freight Inc. has one shareholder whose stock basis is $10,000 at the start of the year. The corporation has $70,000 of ordinary income, $18,000 of non-deductible fines, a $95,000 separately stated loss, and distributes $50,000 in August.

Under Reg. § 1.1367-1(f): basis increases by $70,000 to $80,000. The $50,000 distribution comes next, reducing basis to $30,000 — and because there are no accumulated earnings and profits the whole distribution is a tax-free recovery under IRC § 1368(b). The $18,000 of fines comes third, to $12,000. The $95,000 loss comes last, and only $12,000 of it is allowed; $83,000 is suspended.

Now suppose she had made the Reg. § 1.1367-1(g) election. The $95,000 loss would come third, absorbing all $30,000 with $65,000 suspended, and the $18,000 of fines would carry to the following year instead of vanishing. She trades $18,000 of permanent disallowance for $18,000 of deferral in the loss account, and binds herself to the elected order for the future.

The loan repaid too early

Ackroyd Tooling Inc. owes its shareholder $100,000 on a written note. A bad year reduces his stock basis to zero and then reduces the basis of the note to $35,000. The following year the corporation earns $40,000 and repays the note in full.

Take the two steps in the statute’s order. The $40,000 is a net increase, and a net increase in a subsequent year restores the reduction in the basis of the indebtedness before any of it may increase stock basis, and never above the adjusted basis of the indebtedness at the beginning of the year in which the net increase arises^TY2026 — so it restores the note’s basis first, from $35,000 to $75,000, and nothing is left to increase stock basis. The repayment of $100,000 against a basis of $75,000 produces $25,000 of gain.

Had he waited a further year and let a second profitable year finish restoring the note to $100,000, the repayment would have produced nothing. The face amount of the note is a ceiling on restoration, not a floor on gain.

Traps.

A guarantee is not basis. {fig:basis.sc_guarantee} (Reg. § 1.1366-2(a)(2)(ii)). Nor is a loan the corporation takes directly from a third party, nor a shareholder's pledge of collateral. Only a payment, or a loan that runs from the shareholder to the corporation, creates basis of indebtedness.

Distributions do not reduce debt basis. IRC § 1367(b)(2)(A) reaches only the items in IRC § 1367(a)(2)(B) through (E). A distribution in excess of stock basis produces gain under IRC § 1368(b)(2); it does not consume the shareholder's loan.

Tax-exempt income increases stock basis but not the accumulated adjustments account. IRC § 1367(a)(1)(A) reaches the IRC § 1366(a)(1)(A) items, which expressly include tax-exempt income, while IRC § 1368(e)(1)(A) excludes it from the account. Two accounts, two answers.

The charitable contribution rule cuts the basis reduction, not the deduction. {fig:basis.sc_charity} (IRC § 1367(a)(2), flush text), and {fig:basis.sc_charity_excess} (IRC § 1366(d)(4)). The shareholder deducts the fair market value and reduces basis by the corporation's adjusted basis — the spread is the point of the rule.

Basis is per share, not per shareholder. Reg. § 1.1367-1(c)(3) allocates the adjustments to each share, so a shareholder holding two blocks with different costs has two basis figures. A question that gives two purchase dates is usually testing this.

How this has changed

The charitable contribution basis rule is permanent. IRC § 1367(a)(2) once carried a closing sentence switching the rule off for contributions made in taxable years beginning after a stated date, and Congress extended that date repeatedly — to 31 December 2011, then 2013, then 2014. Pub. L. 114-113 § 115(a) struck the sentence entirely in December 2015. The provision that lets a shareholder deduct the fair market value of appreciated property while reducing basis only by the corporation’s adjusted basis is now a permanent feature, and material written before 2016 that describes it as expiring is stale.

Basis of indebtedness was defined by regulation in 2014. Before then the courts decided whether a shareholder had an “actual economic outlay,” and the case law on back-to-back loans and guarantees was inconsistent. T.D. 9682 replaced that with the bona fide indebtedness standard now in Reg. § 1.1366-2(a)(2)(i) and made the guarantee rule explicit in Reg. § 1.1366-2(a)(2)(ii). Older material framing the question as one of economic outlay is describing a test the regulation has superseded, although it usually reaches the same answer.

Form 7203 made the calculation visible. The shareholder’s basis computation was for many years kept on a worksheet and filed with nothing. It is now reported on a form attached to the individual return, which means an error in the ordering of adjustments is on the face of a filed document rather than in a drawer. Nothing in IRC § 1367 changed; the exposure did.

Exam focus

Expect the ordering of Reg. § 1.1367-1(f) to be tested directly, and know it as a sequence rather than a list: income, distributions, non-deductible expenses, losses. A large share of questions give you all four amounts and a starting basis and ask for one number at the end.

Expect at least one debt basis question, and expect it to turn on the guarantee rule or on a loan that does not run directly from the shareholder. The right instinct on any facts involving a bank is that the shareholder has no basis until they pay.

Know that stock basis and debt basis are separate accounts with a fixed relationship: losses fill stock basis to zero before touching debt, restoration repairs debt before stock, and distributions never reach debt at all.

Finally, distinguish the three accounts that a careless question will conflate — stock basis, debt basis and the accumulated adjustments account. Tax-exempt income is the cleanest discriminator: it raises stock basis and leaves the account alone.

Check yourself

1. A shareholder’s stock basis is zero and her debt basis is $18,000. The corporation distributes $5,000 to her in a year with no income. What does she report?

Answer: $5,000 of gain from the sale or exchange of property under IRC § 1368(b)(2). Her debt basis is untouched — IRC § 1367(b)(2)(A) reduces debt basis only for the loss, deduction, non-deductible expense and depletion items of IRC § 1367(a)(2)(B) to (E), and a distribution is an IRC § 1367(a)(2)(A) item.

2. A shareholder guarantees the corporation’s $200,000 bank loan and pledges securities as collateral. How much basis of indebtedness does she have?

Answer: None. a shareholder does not obtain basis of indebtedness merely by guaranteeing a loan or acting as surety, accommodation party or in any similar capacity; basis arises only to the extent the shareholder actually makes a payment on that indebtedness^TY2026 The pledge does not change the answer. She obtains basis only when she makes a payment on the loan, and then only to the extent of the payment.

3. The corporation contributes property with a fair market value of $90,000 and an adjusted basis of $20,000 to a public charity. A 25 percent shareholder has stock basis of $12,000. What happens?

Answer: She deducts her $22,500 pro rata share of the contribution on her own return, subject to her own percentage ceiling. Her basis is reduced by only $5,000, her share of the corporation’s adjusted basis (IRC § 1367(a)(2), flush text), to $7,000. where the charitable contribution basis rule applies, the loss limitation does not apply to the excess of the shareholder's pro rata share of the contribution over their pro rata share of the adjusted basis of the property^TY2026, so the $17,500 spread is not subject to the loss limitation.

4. A shareholder’s suspended loss is $60,000 when the S election terminates. What becomes of it?

Answer: a loss disallowed in the corporation's last S year is treated as incurred by the shareholder on the last day of any post-termination transition period, limited to the adjusted basis of the stock at the close of that day and reducing that basis by the amount allowed^TY2026 (IRC § 1366(d)(3)). She may deduct it on the last day of the post-termination transition period to the extent of her stock basis at the close of that day, and her basis is reduced by the amount allowed. Anything still unused after that day is lost.

5. A shareholder holds a block of 100 shares bought in 2019 at $40 per share and a block of 100 bought in 2024 at $12 per share. The corporation has a loss of $8,000 for the year. Why does the answer need both figures?

Answer: Because basis is adjusted share by share. Reg. § 1.1367-1(c)(3) allocates the loss to each share, so each block absorbs $40 per share. The 2019 block falls to zero with room to spare; the 2024 block is exhausted and $2,800 of the loss allocable to it is suspended. A single aggregate basis figure would wrongly allow the whole loss.

Change log

2026-08-21Initial draft. Sets out the IRC § 1367(a) increases and decreases with the Reg. § 1.1367-1(f) ordering and the Reg. § 1.1367-1(g) elective ordering, the IRC § 1366(d) loss limitation and its indefinite carryover, the reduction and restoration of debt basis under IRC § 1367(b)(2) and Reg. § 1.1367-2, the Reg. § 1.1366-2(a)(2) bona fide indebtedness test and the rule that a guarantee creates no basis, the open account debt threshold, and the starting basis of stock taken for services under IRC § 83(a) or inherited under IRC § 1014 as modified by IRC § 1367(a)(4).