Question 1

An S Corp shareholder has Stock Basis $0 and Debt Basis $10,000 (loan to corp). In Year 1, the S Corp has an Ordinary Loss of $5,000. In Year 2, the S Corp has Ordinary Income of $3,000 and pays back $4,000 of the loan principal to the shareholder. What is the tax consequence of the loan repayment in Year 2?

Accepted Answer

Year 1: Loss $5k reduces Debt Basis to $5k. Year 2: Income $3k restores Debt Basis first (IRC §1367(b)(2)(B)). Debt Basis becomes $8k. Repayment of $4k is less than Basis $8k. No gain.

Question 2

What mistakes do candidates make on this CPA question?

Accepted Answer

Forgetting that income restores debt basis before stock basis.

How to approach this question

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