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The shareholder’s basis is decreased (but not below zero) by the shareholder’s share of the S corporation’s items of loss and deduction, nondeductible expenses (except expenses that are not chargeable to the capital account), depletion deduction for oil and gas property, and distributions to the shareholder that are not made from accumulated earnings and profits.This helps ensure that the shareholder only benefits once from reductions in income earned by the S corporation.But that section only covers gain on distributions of appreciated property. If the corporation distributes property that has depreciated (i.e., property with a built-in loss), Code § 311(b) does not apply.
This effectively gives the shareholder a credit to apply against the earned income when it is ultimately distributed to the shareholder, ensuring that the income is only taxed once.
The primary difference between C corporations and S corporations is that C corporations are taxed twice on earned income: : once at the corporate level when the income is earned, and again at the shareholder level when the income is distributed.
The rules governing distributions from C corporations differ from the rules that apply to distributions from S corporations.
Corporate shareholders may prefer that the distribution be treated as a dividend, allowing the corporation to take advantage of the special dividends-received deduction under Code § 243 (which allows the dividends to only be taxed once at the corporate level).
On the other hand, individual shareholders often prefer that the distribution be treated as a redemption, for three reasons: A distribution qualifies as a stock redemption only if it significantly reduces the interest of the shareholder in the corporation.