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  1. #1

    Default Tax Basis for Capital Investment in a One-Member LLC

    I'm considering setting up an LLC or S corporation for my new business; it will be a one-owner business. I understand that a one-member LLC is treated as a sole proprietorship by the IRS, and thus, there is no tax basis treatment applied to a one-member LLC with profits unless I take the IRS Form 2253 election for S corp treatment. I'm stuck on the tax-basis treatment of profits and resulting tax treatment. It seems if I invest $10,000, my tax basis is $10,000. If I earn $20,000 first year, only $10,000 is reportable as taxable income--if the Form 2253 election is taken. Thereafter, my basis would be zero until new capital is invested. Do I have this concept correct? Thank you!

  2. #2
    Join Date
    Oct 2014
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    Default Re: Tax Basis for Capital Investment in a One-Member LLC

    Quote Quoting Marinadelreyna
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    I'm stuck on the tax-basis treatment of profits and resulting tax treatment. It seems if I invest $10,000, my tax basis is $10,000. If I earn $20,000 first year, only $10,000 is reportable as taxable income--if the Form 2253 election is taken. Thereafter, my basis would be zero until new capital is invested. Do I have this concept correct? Thank you!
    No, you do not understand it correctly. If you contribute $10,000 to a S-corporation, that is a contribution in exchange for stock in the S-corporation. It gives you $10,000 of basis in the S-corporation stock. If the S-corporation then has a net income of $20,000 in its first year that $20,000 of income flows through to you, and you pay the income tax on that. That income also then adds $20,000 of basis to your stock in the S-corporation. Should the S-corporation then distribute to you $20,000, that distribution reduces your basis in the S-corporation stock by $20,000 but does not create taxable income to you. However, once your basis is reduced to zero, any additional distributions then become capital gain on your S-corporation stock.

    Note that if the S-corporation loses money, that net loss flows through to the shareholder to offset other income on his/her return and reduces the shareholder's basis in the stock. But once the basis is reduced to zero, any additional losses are trapped in the S-corporation and cannot flow up to the shareholder. This is one significant drawback to S-corporations at the start of a new business if losses are anticipated for the first couple of years.

    If you sell the stock of your S-corporation, your gain (or loss) on that sale is the difference between the sale price and your basis in the stock.

    So it's important to track the basis in the stock as it changes from year to year from contributions, distributions, income, and loss because the basis does matter for a lot of things. But the basis does not act to reduce the income the shareholder takes into account from the S-corporation. If the S-corporation makes $20,000 this year, you will have $20,000 of income on your return — regardless of how much basis you have in the stock.

  3. #3
    Join Date
    Sep 2010
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    Default Re: Tax Basis for Capital Investment in a One-Member LLC

    Also note, that if you are actually doing work for the business, the IRS expects you to take a reasoanble amount of the business income as a salary (and pay the SE tax on it).

  4. #4
    Join Date
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    Default Re: Tax Basis for Capital Investment in a One-Member LLC

    Quote Quoting flyingron
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    Also note, that if you are actually doing work for the business, the IRS expects you to take a reasoanble amount of the business income as a salary (and pay the SE tax on it).
    Well, regular SS and medicare taxes paid, via salary, with the employee paying half and the employer (the S-corp) paying the other half. It works out to be the same amount of money as the SE tax, but its not treated that way. It has to be treated as salary if paid out.

  5. #5
    Join Date
    Sep 2010
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    Default Re: Tax Basis for Capital Investment in a One-Member LLC

    Yes, I was sloppy in referring to the nature of those taxes.

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