Debt basis planning is a tool often used by shareholders of S corporations to allow them to use S corporation losses at the shareholder level. The amount of losses that a shareholder can use is limited to her adjusted basis in the S corporation’s stock. When a shareholder loans a corporation money, that loan may in some cases increase her basis in the stock. Loaning an S corporation money, therefore, can in some circumstances increase the amount of losses that a shareholder can use. However, debt basis planning has been a frequent subject of audit and litigation by the IRS, and such planning can be very uncertain.
The IRS has recently issued proposed regulations which may clarify the requirements for debt basis planning. Under the new proposed regulation, indebtedness of an S corporation to a shareholder will increase that shareholder’s basis if it is “bona fide indebtedness.” Some of the factors that might indicate bona fide indebtedness include a legally enforceable written note, appropriate provisions relating to interest, reporting of loans on financial statements, and timely payments on the loan. S corporation shareholders should be aware that debt basis tax planning should be undertaken carefully. However, the proposed regulations indicate that the opportunity to make use of this planning technique to increase the amount of usable losses may be less uncertain than in prior years.
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