SR Glossary: Basis
What’s your basis in your business?
When you own an interest in a partnership or S corporation you may run into issues from time to time regarding “basis”, or simply, how much money you have in the business. Basis can get quite complex but I think it’s worthwhile to give a simple analogy to help provide an understanding:
Say you started a lemonade stand and funded it with $100. If you sold $50 worth of lemonade, you now have $150 in “basis”. If you bought $20 worth of lemons and sugar, you’d now have “basis” of $130 ($100 + $50 – $20). You would have $130 of your money in the business.
You might think that determining your basis in a partnership or S corporation is that simple. However, there are a number of transactions and income tax rules that can complicate the computation. The simple form of the computation is:
Initial cash invested + taxable income + additional cash invested – distributions = Basis
Some other increases to basis may be:
– Tax-exempt income
– Loans from you to from the company
– Recourse debt (company debt that you are personally liable for)
– Purchased interest (you bought into the company by buying out someone that owned an interest in the company; you likely paid him more than his basis in the company. In an S corporation this additional amount is not recorded by the company—it’s called outside basis and you would need to add it to the company’s book basis.
Some other decreases to basis may be:
– The non-deductible 50% of entertainment
– Non-deductible political contributions
– Owner’s health insurance premiums
– Certain flow-through tax credits
– Repayment of loans you made to the company
These are some of the items that might affect your basis computation. Please note that these might not be included in the amount indicated as ending capital on your partnership K-1. Also, your S corporation K-1 does not show your stock basis.
Why is understanding basis important? It is important to be aware of this concept in order to understand when you may be triggering a taxable event or when you may run into various limitations because of basis issues. Also, if you were to sell your interest/stock in a business, your basis will affect the gain or loss on the sale of the investment. More importantly, it may be used annually to determine the amount of tax loss you can deduct.
If this is something you would like to know more about or are concerned that it may affect you, contact us.