Question

Day Corporation, an S corporation, reported a $73,000 ordinary loss for Year 1 (a non-leap year). Day uses the calendar year as its taxable year, as do all of its shareholders. Individual B owns 25% of the Day stock at all times during Year 1. B’s basis in his Day Corporation stock at the beginning of Year 1 was $10,000. B materially participates in Day’s business. At the end of Year 1, Day is liable for the following:
Third-party creditors $15,000
Individual B 3,000
Other shareholders 9,000

What amount of Day’s losses may be deducted by B in Year 1, and what amount of Day’s losses can be carried over by B to Year 2?

Answer 1

Answer:

B's share of Day's losses = 25% x $73,000 = $18,250

B's basis in Day = $10,000 - $18,250 = $0, because a basis cannot be negative.

Since a S corporation is a pass through entity, it is not taxed directly, instead its shareholders are taxed. In this case, B can deduct $10,000 in losses in  year 1. Since the losses cannot exceed B's basis, there is nothing else B can deduct in year 2.