In what order are adjustments to S corporation stock basis generally made for the year?

Increases for income, then decreases for distributions, then nondeductible expenses, then losses and deductions

Distributions first, then income, then losses

Losses, then distributions, then income

Losses and deductions first, then increases for income items, then distributions, then nondeductible expenses last

Which creates debt basis for an S corporation shareholder?

A loan made directly by the shareholder to the S corporation

The shareholder's personal guarantee of a bank loan to the corporation

The corporation's accounts payable to vendors

A loan from a related S corporation owned by the shareholder

After debt basis has been reduced by losses, how is it restored?

Net increases in later years restore debt basis before they increase stock basis

It is restored only when the shareholder advances new funds as a loan to the S corporation

Income increases stock basis first, then debt basis

An S corporation with no accumulated earnings and profits distributes $30,000 to a shareholder whose stock basis (after income adjustments) is $20,000. How is the distribution taxed?

$20,000 is a tax-free return of basis and $10,000 is capital gain

$30,000 is a tax-free return of basis, with the $10,000 excess deferred until sale

An S corporation repays a shareholder loan when the shareholder's debt basis has been reduced below the face of the note by prior losses. What is the result?

The shareholder recognizes gain on the part of the repayment that exceeds the reduced debt basis

The repayment reduces stock basis

The repayment is always tax-free

A shareholder's share of S corporation losses that exceeds stock and debt basis is:

Suspended and carried forward indefinitely, usable when basis is restored

Deductible against the shareholder's wages and other income in the current year without limit

A shareholder contributes property with a basis of $40,000 and FMV of $60,000 to an existing S corporation in a nontaxable transfer. How does this affect stock basis?

Stock basis increases by $40,000

Stock basis increases by $60,000

Stock basis increases by $20,000

S corporation shareholder basis

An S corporation shareholder can deduct losses only up to stock basis plus debt basis from direct loans to the company; stock basis goes up for income, then down for distributions, nondeductible expenses and losses in that order, and Form 7203 reports it.

Updated 2026-09-23 · 4 sources · By the EnrolledAgentKit team

Exam part

Part 2

Businesses

IRS domain

Business Entities and Considerations

30 of 85 scored Qs

Tax year tested

2025

2026-27 SEE

Practice questions

10 free below

The rules the exam tests

Figures for tax year 2025, the year the 2026-27 SEE tests. Verify against the cited primary source.
Rule	What it says (2025)	Source
Stock basis increases	Contributions; share of all income incl. tax-exempt	IRC 1367(a)(1)
Ordering	Income -> distributions -> nondeductible expenses -> losses	Treas. Reg. 1.1367-1(f)
Debt basis	Only bona fide loans made directly by the shareholder; guarantees do not count until paid	Treas. Reg. 1.1366-2
Losses beyond stock basis	Reduce debt basis; excess suspended indefinitely	IRC 1366(d)
Restoring debt basis	Net increases restore debt basis before stock basis	IRC 1367(b)(2)(B)
Distributions (no AE&P)	Tax-free to stock basis; excess is capital gain	IRC 1368(b)
Loan repayment on reduced basis	Gain on excess (capital if note; ordinary if open account)	IRS guidance
Form 7203	Required with losses, distributions, dispositions or loan repayments	Form 7203 instr.

Worked example

Facts: Start of 2025: stock basis $10,000, debt basis $5,000 (direct loan). 2025 K-1: ordinary loss $18,000, tax-exempt interest $1,000; distribution $4,000.

Stock: $10,000 + $1,000 income = $11,000; less $4,000 distribution = $7,000; less loss to $0 ($7,000 used). Debt: remaining $11,000 loss reduces debt basis to $0 ($5,000 used). Deductible loss $12,000; $6,000 suspended.

Exam traps

Distributions reduce basis before losses, which can suspend losses.
Guarantees create no basis until the shareholder actually pays.
Debt basis never absorbs distributions.
Tax-exempt income increases basis.