The Problem of S Corp Shareholder Basis

• June 17, 2019
• Amanda Garnett

Not every challenge our tax team encountered this season was the result of the Tax Cuts and Jobs Act.  When the IRS released the revised Form 1040 earlier this year, there was a small, seemingly innocent, change to the second page of the Schedule E where income from S Corporations is reported that threw us for a loop. 

The IRS added a new column where you check a box if a basis computation is required.  I wouldn’t be surprised if many individuals looking over their return never noticed this box, but it has big potential impact for S Corporations and their owners.

The New Requirement

Per the form instructions, if an individual reports a loss, receives a distribution, disposes of stock, or receives a loan repayment from an S Corporation, they must check the new box and attach a copy of their stock basis computation.  Since most S Corps pay distributions to shareholders, we anticipate that nearly all S Corp bank shareholders are subject to this new provision. 

One of the advantages of being structured as an S Corp is that shareholder basis has the potential of increasing annually as long as taxable income exceeds cash distributions paid to shareholders.  Since shareholder basis ultimately determines the gain or loss a shareholder will be taxed on when their stock is sold, it is a critical calculation but not always an easy one. 

The Basis Problem

Maintaining accurate basis records is a challenge particularly in cases where shares are gifted to family members or inherited upon death.  Since many banks have historically been profitable and their shareholders have not had to worry about the basis limitation rules, some shareholders may not have been keeping complete basis records historically.  This new requirement means those shareholders and their advisors may have to dig through their historic records and go back and create the necessary schedules to attach to their returns.

In some cases, that means going back decades to when the shares were originally purchased or inherited and sorting through more than fifteen years of bank K-1s in order to comply.  We have extended a number of personal tax returns for S corporation owners this year in order to ensure they have adequate time to gather the necessary information.

Who is Responsible?

Keeping track of basis is the shareholder’s responsibility not the corporation’s, at least currently.  Shareholder basis is an individual calculation and is separate from the accumulated adjustments accounts (AAA), which is maintained at the corporate level. 

Though it is common for basis schedules to be provided as part of the K-1s received by shareholders annually, these basis schedules may come with limitations or carve outs because of incomplete information.  Many of the banks we work with are widely-held S Corporations that are often not privy to all of the transactions occurring within their shareholder base. 

Shares may be sold from shareholder A to shareholder B during the year and the bank often doesn’t know the price of that sale.  Or shares may be passed to the next generation upon death, and the bank may not be privy to the fair value assigned to those shares as part of the decedent’s estate.  The more shareholders a bank has the harder it is for the corporation to assist the shareholders in these basis calculations. 

Looking Forward

Though we feel strongly that the maintenance of basis schedules is a shareholder level responsibility and not a responsibility of the S Corporation, this is an area where shareholders often need assistance.  When this new provision came out, a number of our clients were contacted by their shareholders looking for help. 

Corporations can assist by providing copies of prior year K-1s, information on prior stock purchases, stock histories, and other information to assist their owners.  Some S Corporations, particular those with smaller numbers of owners, have decided to maintain complete basis schedules for all shareholders either in-house or with assistance from CLA.

Going forward, there is some concern that shareholder basis may become a corporate level responsibility.  Partnerships, for instance, are required to track the basis of all partners and report that basis directly on partner K-1s.  Banks should consider this future possibility and assess their options going forward. 

CLA is here to help.  Please contact us.

Tags: S Corporations, Shareholder, tax, Tax Reform | Comments Off on The Problem of S Corp Shareholder Basis