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Jonas is a 60% owner of Ard, an S corporation. At the beginning of the year, his stock basis is zero. Jonas’s basis in a $20,000 loan made to Ard and evidenced by Ard’s note has been reduced to $0 by prior losses. During the year, Jonas’s net share of Ard’s taxable income is $10,000. At the end of the year, Ard makes a $15,000 cash distribution to Jonas. After these transactions, what is Jonas’s basis in his stock, and what is his basis in the debt? What is Jonas’s recognized capital gain?

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Answer:

The person ‘J’ basis in the stock is $0.

The person ‘J’ basis in his debt is $0.

The capital gain arises as result of distribution is $5,000

Explanation:

J’ share of net income is $10,000 and the distribution of cash to person ‘J’ is $15,000, therefore, the person ‘J’ basis in his stock is first increased by $10,000 and then decreased by $15,000 but it cannot be negative, hence the person ‘J’ basis in his stock is reduced to $0.

During the current year the person ‘J’ share in taxable income is $10,000, hence there is no loss, So the shareholders ‘J’ basis on debt remains $0 or when the company starts making money again, the basis of loan will automatically increase.

The person ‘J’ basis in his debt is $0.

The capital gain on distribution of cash is calculated as follows;

Capital Gain = Cash Distribution -  J's basis in is stock

=$15,000 - $10,000

=$5,000

Therefore, the capital gain on distribution of cash is $5,000.

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