S Corp Basis Explanation | Distributions in EXCESS of Basis

in this video I'm going to educate you on a concept called S corporation stock basis every single S corporation owner needs to understand this concept but rarely does their account and teach them about it I'm going to show you an example though of how not knowing about this can cost you well over five thousand dollars of taxes now I I'm sure I've already lost some of you already but let me explain why this is important and why you should keep continuing to watch okay and I'll explain this in layman's terms if you take distributions from your S corporation in excess of your basis and I get it right now you don't know what basis might really mean the excess distributions will be taxed as capital gains that might be short-term capital gains which is ordinary income tax or long-term capital gains and it's so easy to make this mistake meaning take distributions in excess of your basis so I want to avoid you making that mistake yourself so please you know keep watching alright so let me try transition over to here I created this for you on Excel um and we can walk through this together also what you're going to learn by watching this is like how a basic profit and loss statement works and balance sheet works so you're gonna learn more than just the basis um topic if you continue watching all right so um here we go let me kind of give you a layout here of what we're looking at I've got these different um colors here right of these different uh values and so one we're going to go over company Financial so this might be your business and what did the numbers look like for the year then I'm going to cover what is the basis um that was that is calculated or occurring while you're doing your business this way and then how it also if you ran your business though this way how much cash you have in the bank and how there's a difference between how much cash in your bank that you have and your impact on your basis and that's where this problem um occurs okay I know it doesn't make a lot of sense right now it's going to though here in a moment so uh we have your business here right this is a p l profit and loss statement you might call it an income statement or whatever so let's just say you have a business with a hundred thousand dollars in Revenue okay and you actually have um the combined value here in expenses which is sixty thousand dollars I just picked these numbers arbitrarily but notice that I kind of disaggregated the amount of expenses you have and I put it in two different categories I said twelve thousand dollars expenses paid and let's say you paid these expenses with cash all right so you either paid with actual physical cash a debit card or a check okay or maybe you use a credit card but you paid down your credit card that's what I mean by twenty five thousand dollars What expenses you actually paid but then you also had in this example thirty five thousand dollars of expenses that you put on a credit card and you did not pay that balance down so at the end of the year you still own Thirty uh five thousand dollars well on your profit and loss statement you could do the math here right 100 minus the 25 minus the 35 you have forty thousand dollars of profit in your business let's look at the balance sheet okay the balance she has a thousand dollars of cash in the bank there's 35 000 dollars you know you'll come to see why there's only a thousand left in the beginning in a second 35 000 in credit card debt right that's this up here thirty five thousand dollars in liabilities and then in equity we have a thousand dollars in Capital stock that means that's just your Capital contribution that you started the business so let's say it's year one you put in a thousand dollars to start this business so you have a thousand dollars in Capital stock you have forty thousand dollars in net income that's this number here but you took seventy five thousand dollars in cash out of the business you took out seventy five thousand dollars in distributions okay well your total Equity now is negative right you took out 75 grand um and so your your equity in the business is now minus thirty four thousand so let's look at um what this what's this concept of basis and um what what's happening to the basis as your business is is being ran this way okay so this concept of basis this is not the technical definition but I'm going to call basis for again in layman's terms um think of it as sort of skin in the game what do you have invested into the business personally okay um and that could be what you have contributed in the form of capital it may be what you've contributed in the form of debt that you've loaned the business it may be um the profits of your business that you've earned have all created basis okay and I'm going to show you that here so you ran your business the same way right you can see it's the same stuff that I had over here on the left 100 Revenue 25 000 of expenses thirty five thousand dollars of expenses that were on the credit card that were not paid yet you have that liability and you have forty thousand dollars in profit okay um so right here you're creating forty thousand dollars of break of basis all right um this thousand dollars of cash that you have in the bank that's not creating basis here it's creating it further down I'll show you that in a second these liabilities are not creating any basis for you you have your Capital stock that's basically uh this money that's the cash in the bank it's it's there in equity um and so you've created a thousand dollars of basis by doing that but then you lost seventy five thousand dollars in basis because you took seventy five thousand dollars of cash out of the business okay so now you actually have technically like a negative basis situation but with an S corporation basis basis cannot go below zero so what you've actually done is reduced your basis down to zero and you have something called distribution in excess of basis okay and so it's thirty four thousand dollars that you've done um and this is taxes capital gains could be short term capital gains or long-term capital gains so let me show you the issue here and then we'll cover these other columns here so I'm going to give you the benefit of the doubt and say that you've had this stock um you know you've you've you've started this business greater than a year ago so your stock was issued more than a year ago but if this is your first year in business it might not it might not be long-term capital gains it might be a short-term capital gain which is ordinary income tax rates which could be taxed if you're in a high tax bracket up to 37 percent so just by you know having this negative basis issue could cost you 12 580 in taxes but I'm gonna be nice and say that it's uh long-term capital gains and you're not making a ton of money and so it's probably taxed at 15 instead of 20 well this mistake is costing you five thousand one hundred dollars okay because you're paying long terms capital gains tax on thirty four thousand dollars okay so you might be wondering like well how did this person even get into this situation to begin with let's look at what's happening here in cash okay how you know if your business operates this way what's happening to the cash uh value or the cash amount okay so let's just assume that when you you know you sold a hundred thousand dollars worth of services or product you got a hundred thousand dollars right so you had a hundred thousand dollars of cash if all this happened on one day right then you had 25 000 in expenses that you actually did pay right remember earlier I said you paid this amount of money with either cash or checks or a debit card but then you had those thirty five thousand dollars of expenses but you didn't pay them they're a liability so you still have that cash in the bank so you actually have 75 000 worth of cash right the 100 you received minus the twenty five thousand dollars of expenses and you've got 75 000. now what else is happening in terms of cash well you have that thousand dollars that you invested right you're sort of your Capital stock you still have that so you really have seventy six thousand dollars in cash at that point um your liabilities don't really affect your cash that's why the a liability you still owe them but then unfortunately you took seventy five thousand dollars in distributions because you didn't realize that this would be an issue so you took the 75 grand out and now your basis is at the end of the year is only um sorry um your cash at the end of the year is only a thousand dollars that you have in the bank right just like we said here your assets are a thousand dollars that's the cash you have in the bank so you see how this can happen you had you thought you had 75 grand that you could distribute to yourself but in reality you only had um about 34 000 or so that you could distribute to yourself without having uh this issue um actually sorry thirty four thousand dollars of the distribution in excess so you had 75 000 um you know minus the 34 000 that you could have distributed so you distributed too much is the is the bottom line here so this is how this could happen right you might be asking yourself well how could someone take out 75 grand this is how because they they purchased a lot of this stuff on a credit card it didn't pay it down how can this be invoided okay let's look at this topic here how can this have been avoided so you can avoid this by paying down the credit card right that would have been smart you could have made a cop a capital contribution to create more bases so at the end of the tax here if your accountant is looking at this they could have said hey you need to put some cash in the bank or you're going to have this issue you could have done a shareholder alone to the business so you the shareholder is putting money into the business in the form of a loan you got to do that properly it can't be a fake loan it can't be just you know saying that you did it there should be a written document there should be a interest rate you should the business should be paying you the interest so it needs to be documented you could have taken less of a distribution all right that could be another way and then any combination of the above you could have done any of these four things a little bit of this a little bit of that and avoided this issue how else can you create this problem well you could create this problem by taking out a business loan receiving the cash and then Distributing the cash to yourself so that's something that I bet I've been saying this like within the sort of CPA Community for a while so many people took out um these eidl loans back when covet occurred received the cash in their business and distributed the whole thing to themselves okay but they didn't report it on their tax return because they're working with a shady tax preparer or a tax preparer who doesn't actually understand how this kind of stuff works okay before I let you go let me show you on the IRS website where you could read more about this if you want to do that on your own and if you're a tax preparer out there watching or CPA watching like um you know I know that there's other issues like debt basis and things like this but I'm trying to just explain this to the average sort of new business owner who doesn't understand those Concepts so I'll leave this in the link in the description below you can go to the IRS website and read this one of the important things I want to highlight here is it says here the IRS like it is not the corporation's responsibility to track a shareholder stock and debt basis but rather it is the share shareholders responsibility it's your responsibility as the business owner to be tracking this um and I'll tell you what a lot of times your tax preparer is not tracking this for years tax preparers didn't really have to fill out any forms to track this but the IRS has said not so fast we're tired of this you are now required as of 2021 tax year 2021 if you take distributions out of your S corporation to file this new form this is why you know the cost of preparing your tax return has increased over the years is because the IRS keeps giving us more work and more forms to fill out and so I'm not going to take you through this form but basically you need to show the IRS in black and white how your stock basis and debt basis is changing and if you take a distribution in excess of your basis you're going to have a problem um I believe it might even say that somewhere here it says I know you don't know what these lines are but if large if line six is larger than line five subtract line five from line six and Report the result as a capital gain on form 8949 and Schedule D see the instructions the instructions will tell you more okay so I'm just letting you know I'm not making this stuff up this is a real problem that's going to happen but uh I know you know the average business owner is not going to really uh care that much so let me know in the comments below what you think for those of you that are watching one of my videos for the first time maybe my name is Navi Mirage I'm a CPA that helps entrepreneurs save thousand dollars in taxes I do that by creating free content on social media um but also via a course I created that teaches business owners all of the strategies I use with my very own clients and my tax practice so you can check that out on my website which is navimaradcpa.com um but with that said don't forget to subscribe share or like this video maybe you have a business partner and you guys have done this together maybe share them be like hey are we in trouble here but if you're watching YouTube you know um check out these other videos that are gonna be playing here in a moment and I'll either see you inside of the course or in the next video

Channel: Navi Maraj, CPA

Views: 24,306

Keywords: s corporation, s corp, distribution, basis, stock basis, debt basis

Id: rrcD7UxZukE

Length: 14min 1sec (841 seconds)

Published: Thu Mar 23 2023