Academic journal article Journal of Accountancy

Proposed Regs. on Basis for S Corporation Shareholders from Bona Fide Indebtedness

Academic journal article Journal of Accountancy

Proposed Regs. on Basis for S Corporation Shareholders from Bona Fide Indebtedness

Article excerpt

On June 11, the IRS issued proposed regulations on when an S corporation shareholder can increase his or her basis in the S corporation's stock based on loans to the corporation (REG-134042-07).

S corporation shareholders, unlike partners, generally are not permitted to increase their basis by guaranteeing a loan made by a third party to the corporation until they have to make payments on the guarantee. They are also not allocated basis from their allocable share of the entity's debt, as a partner is for the partnership's debt. The proposed regulations provide that, to increase a shareholder's basis in indebtedness, a loan must represent the S corporation's "bona fide indebtedness" that runs directly to the shareholder. "Bona fide indebtedness" is not defined in the regulations; rather, general federal tax principles determine whether a debt is bona fide. A shareholder does not obtain basis of indebtedness in the S corporation merely by guaranteeing a loan or acting as a surety, accommodation party, or in any similar capacity relating to a loan, except to the extent the shareholder actually performs under the arrangement (REG-134042-07 preamble; Prop. Regs. Sec. 1.1366-2(iii), Example 2).

As for loans running directly to the shareholder, the proposed regulations address loans made under what the IRS calls the "incorporated pocketbook" theory, in which a shareholder claims that a loan to an S corporation from an entity related to the S corporation shareholder is, in substance, a loan from the related entity to the shareholder, followed by a loan from the shareholder to the S corporation. …

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