Question

On January 1, Year 1, Carrot, an individual, paid $24,100 for 5 percent of the stock in Root Corp., an S corporation. In November, he loaned $12,950 to Root Corp. in return for a promissory note. Root Corp. generated a $920,000 operating loss in Year 1.

How much of his share of the loss can Carrot deduct on his Year 1 return?

Answer 1

Carrot can deduct $37,050 of his share of Root Corp.'s operating loss on his Year 1 tax return, which is limited to his investment and loan to the corporation.

Step-by-step explanation:

The situation involves Carrot, an investor in an S corporation, Root Corp., who needs to determine the deductibility of his share of the corporation's loss on his tax return. An S corporation's loss can flow through to the individual shareholders and be used to offset other income on their returns, subject to certain limitations. In this case, Carrot owns 5% of the stock, so his share of Root Corp.'s $920,000 operating loss is $46,000 (5% of $920,000). However, the deductibility of this loss is limited to his basis in the S corporation.

Carrot's initial stock basis is his investment in the company which is $24,100, and his loan to the company of $12,950 increases his basis to $37,050. Therefore, Carrot can only deduct $37,050 of his $46,000 share of the loss, as it's limited to his adjusted basis in the stock plus any direct loans to the corporation.