Page 210 - TaxAdviser_2022

CASE STUDY

on Jan. 1. L’s stock basis on that date is
M’s stock basis in Example 1 $10,000, and he has no basis from any

Basis, beginning of year $10,000 debt owed to him by S. Losses passed
Nonseparately stated income 9,200 through by S are not limited by the
Basis, before distributions and loss items 19,200 passive activity loss rules or the at-risk
Distributions (6,500) rules, and L has no other capital gain
Basis, before loss and deduction items 12,700 or loss transactions. During the year,
Capital loss (2,000) S distributed $6,500 to L, and his
Basis, end of year $10,700 Schedule K-1 shows the items in the
table “Items From L’s Schedule K-1 in
Example 2.”

Items from L’s Schedule K-1 in Example 2 Because the loss and deduction items
($9,200) exceed the income and gain
Ordinary loss from operations $(9,200) items ($2,000), there is a net negative
Capital gain 2,000
adjustment of $7,200. (These are the
same facts as in Example 1, except in that
example the income item was $9,200 and
S’s AAA and AE&P from Example 2 the loss item was $2,000.)
S’s AAA and AE&P are determined
AAA AE&P as shown in the table “S’s AAA and
Balances, beginning of year $2,500 $6,750 AE&P From Example 2.”
Capital gain 2,000 — L’s stock basis is determined as
Nonseparately stated loss (to extent of gain items) (2,000) — shown in the table “L’s Stock Basis
Balances, before distributions and net negative in Example 2.”
adjustment 2,500 6,750 Note that stock basis is not reduced
Distributions (2,500) (4,000) by the $4,000 portion of the distribu-
Balances, before net negative adjustment 0 2,750 tion that reduced AE&P. L shows that
Net negative adjustment (excess of aggregate amount as a dividend on his Form 1040.
loss and deduction items, $9,200, over income The $2,500 portion of the distribution
and gain items, $2,000) (7,200) — that reduced AAA is nontaxable to L.
Balances, end of year $(7,200) $2,750 His basis was reduced by the loss amount,
so L can deduct the entire $9,200 ordi-
nary loss on his personal return.
on M’s Form 1040, U.S. Individual In- by the excess of loss items over income
come Tax Return. items) as well as the limitation in the Calculating AAA before stock
M’s stock basis is determined as second step (limiting the reduction for basis
shown in the table “M’s Stock Basis in loss items to the increase for income Normally, the same accountant will calcu-
Example 1.” items) will not apply. The limitation and late an S corporation’s AAA and AE&P
Note: Both AAA and basis are ad- the fourth step are necessary only when balance as well as determine the share-
justed by the same items but in a different there is a net negative adjustment; that holders’ bases in stock. However, that will
order. Basis is (1) increased by items of is, when the aggregate loss and deduc- not always be true because calculation
income and gain, (2) decreased by distri- tion items that decrease AAA exceed the of AAA and AE&P is the corporation’s
butions, and (3) decreased by items of loss aggregate income and gain items that responsibility, while keeping track of basis
and deduction. AAA is generally (1) in- increase AAA. is each individual shareholder’s responsi-
creased by items of income and gain, (2) bility. In any event, if the corporation has
reduced by items of loss and deduction, Example 2. Calculation of AAA when AE&P, AAA must be calculated before
and (3) reduced by distributions. there is a net negative adjustment: stock basis is determined because stock
Normally, the step in the fourth bul- L is the sole shareholder of S Inc., a basis is reduced by the nontaxable portion
leted item under “Adjusting AAA in the calendar-year S corporation. S has of the distribution that reduces AAA but
Proper Order” above (decreasing AAA AAA of $2,500 and AE&P of $6,750 not by any portion that reduces AE&P.

40 April 2022 The Tax Adviser