S corporation shareholder recomputation of basis.

• Author: Alberty, Jeff

The IRS recently released draft Form 7203, S Corporation Shareholder Stock and Debt Basis Limitations, to complement Form 6198, At-Risk Limitations; Form 8582, Passive Activity Loss Limitations; and Form 461, Limitation on Business Losses. The new form is required to be filed by an S corporation shareholder to report shareholder basis.

The form is based upon the 2020 instructions for Schedule K-1 (Form 1120-S), Shareholder's Share of Income, Deductions, Credits, etc., that includes an example format for reporting a shareholder's basis computation for prior years. A shareholder needs to know the basis, including when the S corporation allocates a net loss to the shareholder, makes a nondividend distribution, makes a loan repayment to the shareholder, or if the shareholder disposes of stock, among other situations. Despite the requirement to report shareholder basis, shareholders do not always maintain a stock and debt basis computation and thus fail to properly limit loss and deduction items to stock and debt basis under Sec. 1366(d)(1). Failing to properly track basis may require a recomputation of the shareholder's basis.

Computing shareholder basis

Under the normal computation rules, basis is computed by taking beginning basis and adding the items of income, reducing that by nondividend distributions; by nondeductible, noncapital expenses; and, finally, by any other loss and deduction items. Basis cannot be reduced below zero by nondividend distributions; nondeductible, noncapital expenses; and any other loss and deduction items.

Distributions in excess of stock basis are treated as a gain from the sale or exchange of property and reported as a capital gain. The capital gain is long-term or short-term depending upon the shareholder's holding period in the stock.

Loss and deduction items in excess of basis are suspended under Sec. 1366(d)(2) until the next tax year and are carried forward to each succeeding tax year until the shareholder has basis.

If a shareholder completely disposes of the stock while loss and deduction items are suspended under Sec. 1366(d)(2), the loss and deduction items are permanently lost and may not be claimed. Any loss and deduction items suspended under Sec. 1366(d)(2) cannot be used to offset the gain on the sale of the stock.

Failure to properly limit loss and deduction items

Failure to properly limit loss and deduction items to the shareholder's stock and debt basis causes problems for the IRS and return...