Basis Basics for Business Owners: Partnerships & S Corporations (Without the Headache)

If you’re a business owner and your CPA keeps talking about “basis,” it can sound like accounting jargon that doesn’t affect your real life.

But basis is actually one of the most important numbers tied to your tax return—because it controls three big things:

1. How much of your business losses you can deduct

2. How much cash you can take out tax-free

3. How much gain you report when you sell your interest or the business sells assets

   
   

Basis is basically your tax “skin in the game.” The IRS uses it to make sure you don’t deduct more than you’ve economically invested, and you don’t pull money out tax-free that you haven’t already paid tax on.

Let’s break down how basis works for partnerships and S corporations, and why these two are similar in some ways but very different in others.

What “Basis” Means (In Plain English)

Basis is your running total of:

• What you’ve contributed to the business (cash/property)

• Plus income the business allocated to you

• Minus losses and deductions allocated to you

• Minus distributions you’ve taken out

  
  

Think of it as a tax scoreboard tracking what you’ve put in and what you’ve already paid tax on.

If your basis is too low, you can’t deduct losses and you might create taxable income when taking cash out.

Partnership Basis: Two Types (and This Is the Big Deal)

In a partnership (including multi-member LLCs taxed as partnerships), you have:

1) Outside Basis

Your basis in the partnership interest itself (your “ownership basis”).

2) Inside Basis

The partnership’s basis in its assets (what the partnership paid for equipment, buildings, etc.).

Most of what owners care about day to day is outside basis—because it controls loss deductibility and taxability of distributions.

Partnership Basis Starts With:

• Cash you contribute

• Plus the tax basis of property you contribute (usually what you paid, not current market value)

  
  

Partnership Basis Increases With:

• Your share of partnership income

• Additional contributions

• Your share of partnership liabilities (debt)

  
  

And that last point is huge.

Why Partnership Debt Matters

In partnerships, your basis generally includes your share of business debt—even if the loan is in the partnership’s name. That means debt can increase the amount of losses you can deduct and allow more tax-free distributions.

That’s why partnerships can feel “more flexible” from a basis standpoint.

S Corporation Basis: Similar Scoreboard, But Different Rules

In an S corporation, basis is tracked differently. You generally have:

1) Stock Basis

Your basis in your S corporation shares.

2) Debt Basis

Basis from direct loans you personally make to the S corporation (not third-party loans).

S Corporation Basis Starts With:

• What you paid for the shares (or basis of property contributed)

  
  

Stock Basis Increases With:

• Your share of S corporation income

• Additional capital contributions

  
  

Stock Basis Decreases With:

• Distributions

• Losses/deductions

• Nondeductible expenses

  
  

The Key Difference: S Corp Debt Usually Does Not Increase Your Basis

In an S corporation, business debt does not increase shareholder basis unless:

• You personally lend money directly to the S corporation (creating debt basis), or

• You’ve structured a legitimate back-to-back loan (with caution and proper documentation)

  
  

A bank loan to the S corporation—even if you personally guarantee it—typically doesn’t increase your basis.

This catches owners by surprise all the time.

Why Basis Matters: The 3 Rules Every Owner Should Know

1) Basis Limits Loss Deductions

You can only deduct pass-through losses up to your basis.

Example:

• Your K-1 shows a $50,000 loss

• Your basis is only $10,000

  
  

  ✅ You can deduct $10,000

  
  

  ⛔ The remaining $40,000 is suspended and carried forward (until basis increases)

This applies to both partnerships and S corporations.

2) Basis Determines Whether Distributions Are Tax-Free

A distribution is usually tax-free up to basis.

Example:

• You take a $60,000 distribution

• Your basis is $40,000

  • $40,000 is tax-free return of basis

  • $20,000 is taxable income (rules differ between partnerships and S corps, but the concept is similar)

    
    

3) Basis Affects Tax When You Sell

Your gain on sale is generally:

Sales proceeds – your basis = taxable gain

Higher basis = lower taxable gain.

The “Order of Operations” (Where People Get Tripped Up)

Basis is adjusted in a specific order each year. The details differ slightly, but the basic sequence is:

1. Increase basis for income

2. Decrease basis for distributions

3. Decrease basis for losses/deductions

4. Decrease basis for nondeductible expenses

   
   

This matters because basis can swing dramatically depending on timing.

Partnership vs. S Corp: Quick Comparison Table

Topic	Partnership	S Corporation
Debt increases owner basis?	Yes, owners usually get basis from share of liabilities	No, unless shareholder makes direct loan
Two basis concepts?	Outside + inside basis	Stock basis + debt basis
Loss deductions limited by basis?	Yes	Yes
Distributions taxable if > basis?	Yes	Yes
Basis affected by income allocations?	Yes	Yes

Real-World Examples That Make This Click

Example A: Partnership Owner Can Deduct More Because of Debt

You invest $20,000 into a partnership. The partnership takes out a $200,000 loan, and you’re allocated 50% of it.

Your basis might be:

• $20,000 contribution

• $100,000 share of debt

   = $120,000 basis

  
  

So if you’re allocated a $60,000 loss, you likely have enough basis to deduct it.

Example B: S Corp Owner Can’t Deduct Losses Without Direct Loan or Capital

You invest $20,000 into your S corporation. The S corporation takes out a $200,000 bank loan (even if you personally guarantee it).

Your stock basis is still:

• $20,000

  
  

If your K-1 shows a $60,000 loss: You can deduct $20,000 and the $40,000 is suspended until you increase basis (income, contributions, or direct shareholder loan).

This is why S corp basis planning is often about:

• Capital contributions, or

• Shareholder loans done properly

  
  

Basis Planning Tips for Business Owners

Here are the practical takeaways owners should implement:

✅ Track Basis Annually

Don’t wait until there’s a problem. Basis should be updated each year with:

• K-1s

• Contribution records

• Distribution records

• Loan documents (especially for S corps)

  
  

✅ If You Own an S Corp, Be Careful With Loans

If you want losses to be deductible, you need basis. That often means:

• Contributing capital, or

• Making a direct shareholder loan to the corporation

  
  

A personal guarantee usually isn’t enough.

✅ Don’t Assume a Distribution Is Tax-Free

Many owners assume distributions are always tax-free because they already “paid tax on the profits.” That’s often true, but only up to basis.

✅ Basis Is Not the Only Limitation

Even if you have basis, your loss might still be limited by:

• At-risk rules

• Passive activity rules

  
  

Basis is the first gate, not the only gate.

The Bottom Line

Basis is the IRS’s way of saying:

“You can only deduct losses and take money out tax-free to the extent you’ve invested or already paid tax on income.”

Partnerships and S corporations both have basis rules—but partnership owners usually get basis from debt, while S corporation owners generally do not unless they personally loan funds to the business.

If you’re a business owner taking losses, taking distributions, or planning to sell—basis isn’t optional. It’s strategy.