CPA Exam — REG (Regulation)Federal Taxation of EntitiesMedium
A client, an S corporation, reports ordinary business income of $150,000 for the current year. The S corporation also has $20,000 of tax-exempt interest income and $10,000 of Section 1231 gain. The sole shareholder, whose stock basis was $100,000 at the beginning of the year, received a cash distribution of $180,000 during the year. What is the shareholder's ending stock basis?
- A$110,000
- B$90,000
- C$100,000
- D$80,000
Show answer & explanationAnswer & explanation
Correct answer: C. $100,000
Shareholder basis is adjusted by income items, then decreased by distributions. The distribution reduces basis to $90,000, but cannot go below zero for tax-exempt income. The tax-exempt income increases basis, allowing the distribution to fully reduce basis.
Why the other options are wrong
- A. This calculation is incorrect and does not follow the proper order of basis adjustments.
- B. This incorrectly omits the increase for tax-exempt income before reducing for the distribution, or miscalculates the final basis.
- D. This incorrectly assumes the distribution reduces basis below zero before considering tax-exempt income.
S Corp Shareholder Basis Adjustments
An S corporation shareholder's stock basis is adjusted annually for income, deductions, distributions, and other items, influencing the taxability of distributions and the deductibility of losses.
- Basis increases for income items (taxable and tax-exempt) and additional contributions.
- Basis decreases for distributions, non-deductible expenses, and losses/deductions.
- Distributions reduce basis, but not below zero, before considering tax-exempt income and non-deductible expenses.
Memory trick: S-Corp's Basis: Income lifts, Losses lower, Distributions dip, Debt's the driver.