Category: Individuals; Corporations
Subject: Restoration of S Corporation Debt Basis
Title: Exception to General Basis-Timing Rule
IRC Sections: 1367(b)(2)(B)
Filename: 1191.html
Date Produced: 12/96

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-Taxpayer (TP) is an S corporation shareholder.
-At the beginning of 1995, TP had basis suspended losses of $20,000.
-During 1995, TP loaned $20,000 to his S corporation and was able to utilize the basis suspended loss.
-The S corporation had zero taxable income or loss for 1995.
-For 1996, TP's share of S corporation income is $20,000.
-S corporation also repaid TP's $20,000 loan in 1996.

What happens to TP in 1996 as a result of all this?

Generally, basis adjustments to S corporation stock and debt are made as of the end of the tax year in question. Regulation Section 1.1367-2(d)(1). Because the S corporation repaid TP's loan prior to the end of 1996, one would think based on this general rule that TP would be required to recognize income of $20,000 resulting from repayment of zero-basis debt and $20,000 of pass-through income, for a total of $40,000 for 1996.

Income generated by the S corporation can restore previously reduced debt basis. IRC Section 1367(b)(2)(B).

There is an exception to the general basis-timing rule when debts are repaid prior to year end. If debt is disposed of or repaid in whole or in part, basis restoration takes place immediately prior to the disposition or repayment. Regulation Section 1.1367-2(d)(1).

Accordingly, the $20,000 income passed through to TP in 1996 restores his basis in the loan to the S corporation. Thus, when the loan is repaid, it is not necessary to recognize income on the repayment and income from the pass through. As a result, TP merely recognizes the $20,000 pass-through amount in 1996.