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S corporation basis: is it time for an S corporation holding company?

December 10, 2009

Entrepreneurs are restless. It's not unusual for them to have a lot of things going on, with a different S corporation for each business. When one business has losses, the entrepreneur takes funds out of the successful businesses to finance them. But when the entrepreneur runs low on basis in the money-losing S corporation, this can lead to problems. You can only deduct S corporation losses if you have basis in S corporation stock or debt.

The man who started the successful Dart Transportation business had this problem a few years back. He borrowed money from his S Corporation A and then loaned it to S Corporation B to get basis to deduct the losses. S Corporation B then loaned the funds back to S Corporation A, and the money was all back where it started.

The IRS didn't like this, and after a long court battle, the IRS won. The courts said, in effect, that because the cash ended up where it started, the intervening steps -- the loans -- didn't count.

Even if the loans do count, an S corporation owner can get surprised with taxable income if the corporation repays shareholder loans before the corporation has had enough profit to restore basis used to take losses.

An S corporation holding company can avoid these problems. S corporations can own other S corporations if they own 100% of the stock and make a Qualified Subchapter S Subsidiary (QSUB) election. The QSUBS retain their identity under state law, but they are "disregarded entities" for computing taxes. This structure allows you to put all of your S corporation stock basis in one place, eliminating the need to throw money around at year end to deduct losses. Your corporations remain separate legal entities, protecting them from each other's problems. But if you want to do this by year-end, get together with your lawyer and tax pro right away, because time is short this year.

This is another installment in our 2009 year-end tax planning tips series. Don't miss a one!

Tags: basis.S corporations.year-end tax planning.