Suppose Clampett, Incorporated, terminated its S election on August 28, 2020. At the end of the S corporation's short tax year ending on August 28, J.D.'s stock basis and at-risk amounts were both zero (he has never had debt basis), and he had a suspended loss of $20,000. In 2021, J.D. made additional capital contributions of $5,000 on March 15 and $12,000 on September 5. How much loss may J.D. deduct in 2021?
A)$0
B)$5,000
C)$17,000
D)$20,000
E)None of the choices are correct.

Question

Quizplus · Accepted Answer

When an S corporation terminates its S election, section 1366(d)(1) requires the corporation to allocate any suspended losses of its shareholders based on the "ordering rule." This means that any suspended losses that were incurred in a taxable year during which the corporation was an S corporation must be allocated to shareholders first, up to the amount of the shareholder's stock basis in the S corporation as of the last day it was an S corporation. Any remaining suspended losses are then allocated to shareholders with respect to their debt basis, and any losses that still remain are then passed through to the shareholder's at-risk amount.

In this case, J.D.'s stock basis was zero as of August 28, 2020, the last day the corporation was an S corporation. Therefore, J.D. can only deduct suspended losses that were allocated to him with respect to his capital contributions made after August 28, 2020.

J.D. made capital contributions of $5,000 on March 15, 2021, and $12,000 on September 5, 2021. These contributions increase J.D.'s stock basis in Clampett, Incorporated to $17,000 ($0 + $5,000 + $12,000). Therefore, J.D. can deduct suspended losses of up to $17,000 on his 2021 individual income tax return. Since J.D.'s suspended loss amount is $20,000, he can deduct the entire $17,000 in 2021, and the remaining $3,000 can be carried forward to future tax years.

Suppose Clampett, Incorporated, Terminated Its S Election on August 28