It’s important to keep track of a shareholder’s basis in order to determine if the shareholder can deduct pass-through losses. The amount of pass-through losses a shareholder can deduct is limited to the shareholder’s basis in the S corporation stock and adjusted loan basis. Losses that exceed a shareholder’s basis in the S corporation are not currently deducted, but are suspended and carry over to the following year. The IRS states that an S corporation shareholder’s basis must be reduced by any losses allowed and is not limited to losses that were actually claimed as a deduction.
Shareholders must adjust their basis annually by their capital contributions, pro rata share of pass-through income or loss from the S corporation and distributions. An exception is made when a shareholder cannot increase his or her basis by any amount of pass-through income that was required to be reported by the shareholder and included in gross income, but that the shareholder failed to report on his or her tax return.