IRS issues guidance for S corporation shareholders

 

The IRS recently issued a new draft Form 7203, S Corporation Shareholder Stock and Debt Basis Limitations, and the corresponding draft instructions for comment.

For the past several years, the IRS has required shareholders of an S corporation to disclose a stock and debt basis computation with their return if the shareholder claims a deduction for their share of an aggregate loss, receives a distribution, disposes of stock or receives a loan repayment from an S corporation.

There was no specified form to report the basis computation—instead the IRS directed shareholders to a Worksheet for Figuring a Shareholder’s Stock and Debt Basis in the Shareholder’s Instructions for Schedule K-1 (Form 1120-S).

The IRS is formalizing the basis computation worksheet into a form, but with some proposed modifications. The largest change is the option to report stock basis through stock blocks. A stock block is a specifically identifiable block of stock that either has a different stock basis compared to other shares of stock or a different holding period. For example, if a father and son form an S corporation with equal ownership on Jan. 1, 2010, and the father passes away and bequeaths the stock to son on Jan 1, 2020, then the stock is included in the father’s estate and the father’s stock block will be adjusted (up or down) to fair market value. The son will now own two blocks of stock with different holding periods and potentially with different bases. Under the current proposal, the son has the option to report the basis in each stock block separately.

Generally, stock block reporting would only be required if a stock block is disposed of in a partial disposition of the S corporation stock. This is because if an item affecting the stock basis like losses or distributions results in a particular stock block basis being reduced to zero, the shareholder is allowed to reduce the basis from a different stock block so that the remaining loss can be claimed or the distribution reported as a return of capital. Hence when a shareholder has multiple stock blocks it is common for the shareholder to only report one block of stock unless an event occurs requiring a separation of the stock blocks for basis computation purposes (like a partial sale of the shareholder’s stock).

As this is a proposed change, the final form may provide for a required reporting by stock block or stock block reporting could be removed, but required reporting or removal is considered unlikely at this time.

There are other changes in the form instructions—however the changes are unlikely to remain in the final version and therefore are not discussed further here.

Taxpayers should be sure to include an amount in the fee estimate for 2021 returns to review and prepare the new form for any S corporation shareholders. Or, if a shareholder does not know their basis, taxpayers should consider performing a study to recreate the basis computation schedule going back to when they first acquired an interest in the S corporation.

 

 

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