S Corporation At-Risk Rules
Do you own interest in an S-Corporation (“S-Corp”)? If so, the IRS at-risk rules may apply to you and may limit the loss deductions you will be allowed to take. The IRS at-risk rules may also apply to partnerships, LLCs and closely-held C corporations (subject to certain exceptions), so they may be important to learn if you hold an interest in such entities.
This article will explain the basics of the at-risk rules in the context of S-Corps. It is not intended to provide tax or legal advice. S-Corp taxation can be a very complex area, so you may wish to seek the advice of a competent, experienced attorney. Sherayzen Law Office, Ltd. can assist you in all of your tax and legal needs.
A Taxpayer’s At-Risk Amount
In an S-Corp, the deductibility of a distributed loss may be determined by three separate limitations: (1) The shareholder’s adjusted basis of an interest, or the shareholder’s stock plus any loans made by the shareholder to the entity, (2) the at-risk rules, and (3) the passive activity rules. As noted, this article will cover the at-risk rules (the other limitations will be covered in future articles).
Under the Internal Revenue Code Section 465, a taxpayer is considered to be at-risk for an activity with respect to amounts including, “(A) the amount of money and the adjusted basis of other property contributed by the taxpayer to the activity, and (B) amounts borrowed with respect to such activity” to the extent that the taxpayer is, “(A) is personally liable for the repayment of such amounts, or (B) has pledged property, other than property used in such activity, as security for such borrowed amount [to the extent of the net fair market value of the taxpayer’s interest in such property].”
According to the IRS, any of the following activities for a trade or business that produce income will subject a taxpayer to the at-risk rules: “Holding, producing, or distributing motion picture films or video tapes. 2. Farming. 3. Leasing section 1245 property, including personal property and certain other tangible property that is depreciable or amortizable… 4. Exploring for, or exploiting, oil and gas. 5. Exploring for, or exploiting, geothermal deposits [for wells started after September 1978]. 6. Any other activity not included in (1) through (5) that is carried on as a trade or business or for the production of income.” Taxpayers will not be considered at-risk for amounts of nonrecourse financing that protects against losses, guarantees, and other related arrangements.
In general, the at-risk rules do not apply to the holding of real property placed in service before 1987 or to the holding of an interest in a pass-through entity acquired before 1987 that holds real property placed in service prior to 1987. Mineral property holdings, however, are not included in this exception.
Separate Activities or One Activity?
In most S-Corps, the business will be engaged in many different types of transactions and activities. Thus, it will often be necessary to determine whether the loss limitation at-risk rules apply to each activity, determined separately. Every shareholder in an S-Corp should receive a schedule stating their profit or loss share of each separate activity.
However, activities that constitute a trade or business must be aggregated into one activity if a shareholder actively participates in the management of the trade or business, or 65% or more of the losses in a partnership or S-Corp are allocable to individuals who actively participate in the management of the trade or business. Additionally, certain leased items, among others, may be treated as one activity.
Contact Sherayzen Law Office for Help With S-Corporation Tax Issues
If you have any tax questions regarding your S-Corp, contact the experienced tax law firm of Sherayzen Law Office.
Pursuant to IRS Circular 230, any advice rendered in this communication on U.S. tax issues (i) is not intended or written to be used, and it cannot be used, for the purpose of avoiding penalties imposed by the U.S. Internal Revenue Service, and (ii) may not be used or referred to in promoting, marketing or recommending a partnership or other entity, investment plan or arrangement.