ExpertHard1 markMultiple Choice
CPA · Question 32 · Area II: Entity Tax Compliance
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?
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?
Answer options:
A.
No gain or loss.
B.
$1,000 Gain
C.
Wait, let's recalculate. See explanation.
D.
$0 Gain (Fully restored)
How to approach this question
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.
Full Answer
D.$0 Gain (Fully restored)✓ Correct
D
Year 1: Debt Basis starts $10k. Loss $5k reduces it to $5k. Year 2: Income $3k restores Debt Basis to $8k. Repayment is $4k. Since Repayment ($4k) < Basis ($8k), there is no gain. The basis is simply reduced to $4k. (Note: If repayment exceeded basis, gain would occur).
Common mistakes
Forgetting that income restores debt basis before stock basis.
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