Basis is an important concept for determining how a shareholder calculates the tax implications of many different situations and events related to their ownership in an S Corporation. There are two kinds of basis that a shareholder can have in an S Corporation: stock basis and debt basis. A common question related to shareholder basis is this: does a shareholder increase their basis in an S Corporation by the amount of credit card liability that the S Corporation carries if the shareholder personally guarantees the credit card debt?
The answer to this question is found in Treas. Reg. § 1.1366-2(a)(2)(ii), which states the following:
Given that credit card debt is really just another type of loan or revolving credit… that’s a pretty flat “no”. However, it’s also not the full story. Here’s the rest of what Treas. Reg. § 1.1366-2(a)(2)(ii) says:
So the shareholder may ultimately be able to increase their debt basis in the S Corporation for the portion of the S Corporation’s debt they personally guarantee, but only if they ultimately have to make payments to satisfy that guarantee. Here is an example, which is derived from Example 4 in Treas. Reg. § 1.1366-2(a)(2)(iii):
|Megan is a shareholder of Spiffy Widgets, an S Corporation. Spiffy Widgets successfully applies for a business credit card from Big Bank, but Big Bank requires Megan to personally guarantee the business credit card account. Spiffy Widgets spends $1,000 on the credit card and carries the balance through the end of the year. During that year, Megan will not increase her debt basis in Spiffy Widgets. During the next year, it’s determined that Spiffy Widgets will not be able to pay the $1,000 credit card liability, and Megan pays off the liability with her personal funds. During the year that Megan makes the $1,000 payment in satisfaction of Spiffy Widget’s debt that Megan personally guaranteed, Megan will increase her debt basis in Spiffy Widgets by $1,000.|
Based on this example, the underlying theory is that the shareholder’s basis in the S Corporation is increased when the shareholder actually puts forth personal funds toward the business. This is consistent with how shareholder loans (i.e. loans a shareholder directly makes to the S Corporation) and cash contributions affect shareholder basis.
This also presents some potential tax planning opportunities. If you have an S Corporation that you expect to have some loss years and the shareholders would like to be able to deduct those losses on their individual tax returns, then shareholder loans to the S Corporation are preferable to the S Corporation taking on debt from a third party, such as from a business loan or credit card.