Proposed regs. on basis for S corporation shareholders from bona fide indebtedness

On Monday, the IRS issued proposed regulations on the contentious subject of when an S corporation shareholder can increase his or her basis in the S corporation’s stock, based on loans to the corporation, and thereby increase the amount of the corporation’s losses and deductions the shareholder can recognize (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 actually 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. As a result, S corporation shareholders spend a lot of time trying to avoid these rules and create basis that will allow them to deduct losses.