If you're grappling with the concept of shareholder basis and why it's crucial for your S Corp, you're in the right place. We'll unpack everything in easy-to-understand terms and help you utilize this knowledge to manage your business's finances better.
The Basics of Shareholder Basis
Shareholder basis in an S Corp starts from the first day the corporation exists and adjusts each year. It's essentially a measure of your investment in the company. Increases in your shareholder basis can come from your net taxable income and contributions to the business. However, distributions you take out and any losses the business incurs will decrease your basis.
Why Is This Important?
Knowing your shareholder basis is crucial because it determines how much cash you can take out of the business through distributions without triggering additional taxes.
If your basis falls into the negative, any excess distributions could be subject to double taxation at capital gains rates. Also, maintaining a healthy basis ensures that your distributions are treated as a return on capital and are not taxable.
How Shareholder Basis Works
Increases to Basis
Your basis can increase through:
Net Taxable Income: This is your gross receipts minus qualified expenses.
Shareholder Contributions: These are typically cash contributions that a shareholder makes to the business, which then become part of the business's capital.
Retained Earnings: This represents the cumulative net income (minus distributions) from the start to the current point of your business.
Decreases to Basis
Your basis can decrease through:
Distributions: Money or other assets taken out of the business for personal use, which aren't taxable as long as your shareholder basis covers them.
Losses Reported by the Business: If your business reports a loss and you have sufficient basis, you can report this loss on your individual tax returns, potentially reducing your overall taxable income.
Cash Value and How It’s Affected
The cash value you can take from the business can vary widely throughout its life. It’s influenced by many factors including the business's earnings, contributions you've made, and how much you've previously taken out.
Example Calculations
If this article piqued your interest and you're keen on digging deeper into how shareholder basis is calculated with practical examples, click here to access our detailed presentation. Don’t worry; we keep the math simple—just some addition, subtraction, and a bit of multiplication.
Practical Tips
We recommend keeping one to two months' worth of revenue in your business bank account to help manage cash flow and prevent any accidental tax liabilities.
Checking your basis
At Collective, we track your shareholder basis so you can make informed decisions about distributions. Wondering about your current basis? A quick check is to log into your accounting software, run a balance sheet report up to today, and look at the 'total equity' line. If it’s positive, you’re generally good to go; if it’s negative, it’s time to connect with us.
Our goal isn’t to make you an overnight expert in shareholder basis, but rather to ensure you’re aware of its significance. This knowledge can shape some of our key recommendations for your business. Got questions? Please feel free to email us at [email protected], and we’d be delighted to help you navigate through your queries.
Disclaimer: The information contained in this document is provided for informational purposes only and should not be construed as financial or tax advice. It is not intended to be a substitute for obtaining accounting or other financial advice from an appropriate financial adviser or for the purpose of avoiding U.S. Federal, state or local tax payments and penalties.