Category: Corporations
Subject: S Corporation Termination
Title: Effect of Revocation: Gain Recognition as a Result of Losses in Excess of Stock Basis
IRC Sections: 1362
Filename: 1353.html
Date Produced: 12/94

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Facts
A shareholder of an S corporation has made a loan to the corporation to support losses in excess of his stock basis. The corporation's S election will be revoked effective 1/1/95.

Issue
Does the revocation trigger gain recognition as a result of losses in excess of stock basis?

Answer
Revocation of the S election does not cause gain recognition due to losses in excess of stock basis; however, the shareholder will recognize gain when the loan is repaid.

Discussion
The basis of an S corporation shareholder's stock is reduced, but not below zero, by losses passed through from the S corporation. If the shareholder's stock basis is insufficient to absorb all available losses, the basis of loans from the shareholder to the corporation can also be reduced in order to increase the shareholder's ability to currently enjoy S corporation tax losses. In this case, the shareholder has made a bridge-loan at year end in order to utilize the pass-through of losses for the current year. I see nothing in the literature to indicate that these excess losses trigger gain as a result of loss or revocation of S corporation status.

It is clear, however, that repayment of the bridge loan will cause recognition of gain. In essence, the tax basis of the loan is less than its face as a result of the previous basis reduction for losses in excess of stock basis. When the bridge loan is repaid, the loan (presumably a capital asset in the shareholder's hands) will be satisfied at an amount in excess of its tax basis thus giving rise to capital gain to the shareholder.