Proposals Lower S Corp Debt Basis Determination Hurdle for Shareholders

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IRS is proposing to do away with the much litigated and disliked economic outlay test used to determine S corporation shareholders' basis of indebtedness for purposes of deducting their share of corporate losses. The test is special to S corporations, and it did not make much sense, sources tell BNA following the release of the proposed rules (REG-134042-07). The move generally adopts recommendations by AICPA and ABA. While IRS did not go as far as it could have, the move is likely to be welcomed by the practitioner community, sources say. The new, lower hurdle is a clearer test that is helpful to the preparer, although it may or may not give taxpayers more deductions, they say. The new test, or standard, is the bona fide test, which would allow an increase in the shareholder's basis only if the indebtedness of the S corporation to the shareholder is a result of bona fide indebtedness.