Frequently Asked Questions
What are the tax implications of not adjusting the original stock basis when selling the stock?
The tax implications of not adjusting the original stock basis when selling the stock can be significant. When you invest in an S corp, your initial basis in the stock is equivalent to your investment.
For instance, if you invest $500, your initial basis is $500. If the S corp earns income, this income is not taxed at the business level but is sent to you on a Schedule K-1, and you pay taxes on this income.
If the business retains this income, the stock value increases. If you sell the stock without adjusting the original stock basis, you will pay taxes twice on the same income earned by the business - once when it was earned and allocated to you, and again upon selling the stock.
This is because, according to Section 1001, the sale will increase to $100 of gains if you have not adjusted the original $500 stock basis. Therefore, it is crucial to adjust the stock basis when the S corp gives you income. If you enhance the stock basis from $500 to $600 when the S corp gives you the $100 in income, and then sell the stock for $600, you get no additional gain.
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