Question 1

A shareholder of an S Corporation has a stock basis of $10,000 and a debt basis of $5,000 (from a direct loan to the corp) at the beginning of Year 1. In Year 1, the S Corp reports an ordinary loss of $20,000. In Year 2, the S Corp reports ordinary income of $8,000. No distributions are made. What is the shareholder's debt basis at the end of Year 2?

Accepted Answer

Ordering: 1. Loss reduces Stock Basis to 0. 2. Loss reduces Debt Basis to 0. 3. Subsequent Income restores Debt Basis FIRST, then Stock Basis. Year 1: Used $5k debt basis (now 0). Year 2: $8k income. $5k suspended loss from Year 1 is treated as incurred in Year 2. Net increase = $3k ($8k income - $5k loss used). Debt basis restored by net increase: $3k.

Question 2

What mistakes do candidates make on this CPA question?

Accepted Answer

Restoring stock basis first; forgetting to net the suspended loss usage against the income for the basis increase calculation.

How to approach this question

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