Entity taxation
The Passthrough Basis
Basis rises with income and contributions, falls with losses and distributions, and never drops below zero.
How the exam words it
- -The stem tracks an S corporation shareholder's stock and debt basis through income, losses, and distributions.
- -A partner's outside basis changes with contributions, income, and a share of liabilities.
- -A distribution exceeds basis and it asks how much gain is recognized.
- -An S corporation with accumulated E&P makes a distribution and it asks about the AAA ordering.
The playbook
- 1Order the annual basis adjustments: increase for contributions and income items, then decrease for distributions, then for losses, so a distribution is measured before the loss.
- 2Limit deductible losses to stock plus debt basis for an S shareholder, or to outside basis for a partner; the excess carries forward.
- 3Include a partner's share of partnership liabilities in outside basis, which has no counterpart for an S corporation shareholder, where only a direct loan creates debt basis.
- 4Treat a distribution above basis as capital gain, and for an S corporation with E&P run the AAA first, then a dividend from E&P, then a return of basis.
The trap
Giving an S corporation shareholder basis for entity-level debt. Only a direct loan from the shareholder creates debt basis; a partner, by contrast, does include a share of partnership liabilities in outside basis.
How the exam varies it
The same pattern, re-skinned along these axes:
S corporation stock and debt basis versus partnership outside basisThe ordering of income, distributions, and lossesA distribution in excess of basis versus the AAA and E&P layering
Drill this pattern
8 questions of The Passthrough Basis from across the AUD topics. Clear it by getting 5 right with a streak of 3.