At the beginning of the year (Jan 1), Steve and Sally formed an S-corporation who are equal shareholders. Each gave $5,000 in exchange for stock. Sally loaned the S-corp an additional $5,000 on June 30th. The business had an ordinary loss in its first year of $12,000 and ordinary income in its second year of $15,000. Assume that all parties use a calendar based taxable year and that neither the passive nor at-risk limitations are applicable.
How much income does each shareholder recognize in the second year?
A.Each recognizes $7,500 of income.
B. Steve recognizes $6,500 of income and Sally recognizes $7,500 of income.
C.Steve recognizes only $6,500 of income while Sally recognizes $8,500 because she got to deduct more of the first year’s loss than Steve.
D.Each recognizes only $6,500 of income because their first year loss deduction was limited to their equity contributions.