Why Average Isn’t Enough: Understanding Shareholder Basis in an S-Corporation
- Jose Ortiz, CPA, CTC
- 4 days ago
- 4 min read
Too often, entrepreneurs and high earners assume that working with a CPA is enough to stay safe and compliant. But average doesn't protect you. Average doesn’t plan ahead. Average CPAs react to tax problems—they don’t prevent them.
At The Scale Collective, we created this series to expose the blind spots and missed opportunities that plague traditional, checklist-driven tax work. We believe proactive strategy should be the standard, not the exception. “Why Average Isn’t Enough” is our response to the hidden costs of mediocrity—and a roadmap for what real strategy looks like.
And few places reveal the difference more clearly than shareholder basis in an S-Corporation.
The Overlooked Risk: Basis Mismanagement
If you own an S-corporation—or work with clients who do—understanding shareholder basis is non-negotiable. Yet it’s one of the most overlooked and misunderstood components in the entire S-corp structure. And when CPAs treat it as an afterthought, the fallout can be costly.
Distributions become taxable. Deductions get disallowed. Strategy becomes damage control.
At The Scale Collective, we don’t just record what happened—we guide what should happen. This is exactly where the average CPA gets it wrong.
The Strategy Behind Basis
S-corps are pass-through entities, which means the income flows to the shareholders’ personal returns. But what the IRS allows you to take out and deduct depends entirely on your basis.
What is Basis?
Your basis is your tax investment in the S-corporation. It controls three major areas:
How much loss you can deduct
Whether a distribution is taxable
What happens when you sell your shares
Each year, your basis is adjusted up or down based on company performance and shareholder activity.
The Two Types of Basis: Stock and Debt
Stock Basis
This is the most common type. It starts with:
The amount paid for the shares
Capital contributions
Income passed through (even if not distributed)
Tax-exempt income
It’s reduced by:
Distributions (taxable or not)
Losses and deductions passed through
Non-deductible expenses
Stock basis is required for taking distributions tax-free and deducting losses. You can’t just guess your number—it needs to be tracked annually.
Debt Basis
Debt basis only applies when a shareholder personally lends money to the S-corp.
This doesn’t include:
Loans from banks
Third-party loans you guaranteed
It must be a direct loan from the shareholder to the business.
Debt basis is crucial when stock basis hits zero. It can allow loss deductions to continue, but it does not support tax-free distributions.
What the Average CPA Will Say (and Miss)
Average CPA: “You can’t deduct this loss because you don’t have basis.” [After the fact. No warning. No solution.]
Strategic CPA: “You’re projected to have losses this year. Let’s explore restoring basis before year-end—either by accelerating income, contributing capital, or issuing a direct loan.”
Average CPA: “There’s enough cash for a distribution.” [No basis check.]
Strategic CPA: “There’s $50K in the bank, but you only have $30K of stock basis. If we distribute the full amount, $20K will be taxed as a capital gain. Let’s get ahead of that.”
Average CPA: “Here’s your K-1.” [No Form 7203, no basis schedule.]
Strategic CPA: “Your return includes Form 7203, and your updated basis schedule is ready. This year’s loss will be partially suspended, and we’ll plan ahead for next year.”
Why Basis Matters to Strategic Planning
Loss Deductibility Losses can only be deducted if you have enough basis. No basis, no deduction. It doesn’t matter if the business lost real money—your tax return doesn’t care unless basis is in place.
Distributions You can only take money out tax-free up to your stock basis. Anything above that becomes a capital gain—even if you already paid tax on the income.
Preventing IRS Issues Incorrect basis calculations lead to disallowed deductions, recharacterized income, and IRS notices. It’s not a matter of if—it’s when.
The Dangers of Negative Basis
Basis can’t legally be negative. If losses or distributions exceed basis:
Further losses are disallowed
Distributions become taxable
You may owe taxes on income you didn’t actually receive
This is where the stakes get real. Once basis goes negative, it triggers a compliance headache—and the IRS will find it, even if your CPA didn’t.
Basis Is Your Responsibility—But Your CPA Should Be Tracking It
The IRS doesn’t track shareholder basis. That’s your job—or your CPA’s. But many don’t do it unless you ask.
Starting in 2021, the IRS added Form 7203, which must be included with the return if you're taking losses, distributions, or selling shares. Without it, deductions may be denied automatically.
If your CPA isn’t including Form 7203—or if you’ve never seen a basis schedule—you’ve got a problem.
Strategic Moves to Manage Basis
Proactively Build Basis Before Year-End If you expect a loss, plan ahead. Increase basis by contributing capital, lending money, or recognizing income.
Don’t Take Distributions Without Checking Basis Having cash in the business doesn’t mean you can take it tax-free. Always confirm your basis first.
Document Shareholder Loans Properly If you plan to use debt basis, set up real loan documents. You need more than a “verbal agreement” or a transfer on your personal Venmo.
Track Basis Every Year Make it part of your annual process. Don’t wait until the IRS asks for it.
Final Word
Most CPAs check boxes. Strategic CPAs build guardrails.
Tax planning isn’t about reacting—it’s about anticipating. If your CPA hasn’t talked to you about basis—or worse, has never tracked it—it’s not just a missed opportunity. It’s a risk.
“Why Average Isn’t Enough” exists to challenge the status quo. Because smart, forward-thinking clients deserve more than average.
And in the world of S-corps, understanding basis is where strategic tax planning begins.
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