CPA Exam — REG (Regulation)Federal Taxation of EntitiesMedium
A client, a qualified S corporation, has a single shareholder, Alex, whose basis in his stock is $40,000 at the beginning of the year. During the year, the S corporation reports ordinary business income of $30,000, municipal bond interest income of $5,000, and makes a cash distribution to Alex of $20,000. What is Alex's ending stock basis?
- A$55,000
- B$40,000
- C$35,000
- D$60,000
Show answer & explanationAnswer & explanation
Correct answer: A. $55,000
Shareholder basis is adjusted for income, then distributions. Beginning basis $40,000. Ordinary income $30,000 increases basis to $70,000. Tax-exempt income (municipal bond interest) $5,000 also increases basis to $75,000. The cash distribution of $20,000 decreases basis. So, $75,000 - $20,000 = $55,000 ending basis. Note: Tax-exempt income increases basis to ensure the shareholder is not taxed on its distribution.
Why the other options are wrong
- B. Incorrect. This does not account for income or distributions.
- C. Incorrect. This would result if tax-exempt income was not included, or if distributions were applied before income.
- D. Incorrect. This would result if the distribution was not subtracted.
S Corp Shareholder Basis Adjustment
S corporation shareholder stock basis is adjusted yearly for income, gains, losses, deductions, and distributions, generally in a specific order.
- Basis increases for income (taxable and tax-exempt).
- Basis decreases for losses and deductions.
- Basis decreases for distributions.
- Order of adjustments matters: income/gain first, then distributions, then losses/deductions.
Memory trick: Income Up, Losses Down, Distributions Out.