Beginning in 2018, the IRS has expanded the requirement for individuals to attach S corporation tax basis schedules to their tax return. Specifically, an individual who has a loss, distribution, stock disposition, or loan repayment from an S corporation must attach the stock and/or debt basis calculation to their tax return. Additionally, the 2018 form Schedule E, Part II, has a new check box requiring an individual to affirmatively indicate when the S corporation basis computation is required to be attached.
The concept of shareholder basis is somewhat simple, however the calculation can be cumbersome if it was not properly tracked by the shareholder over the years. It is important to note that it is not the corporation’s responsibility to track a shareholder’s stock and debt basis, but rather it’s the shareholder’s responsibility. As many small business taxpayers in the construction industry are organized as S corporations, this is an important concept that can be overlooked and unknowingly lead to unintended consequences. Knowing your shareholder basis is important if:
With how volatile the construction industry can be, it is imperative that all shareholders of a construction company know what their basis is. Without knowing their basis, S corporation shareholders are at risk of over or under stating their taxable income in a given year. For example, the fact that a shareholder receives a K-1 reflecting a loss does not mean that the shareholder is entitled to claim that loss automatically; you must have adequate basis to claim the loss. Additionally, one of the main benefits of being an S corporation is the single layer of taxation (i.e. tax free distributions), however distributions are only tax free to the extent they do not exceed stock basis.
This was an area for potential abuse by taxpayers and the IRS took action as part of tax reform by instituting this new requirement for basis schedules to be attached when the information is pertinent to the taxpayer’s return. The requirement for a shareholder to maintain their basis is not a new requirement, only the disclosure of the calculation. However, practically speaking many shareholders do not have a good grasp on what their basis is and they must now look to recalculate it.
The difficultly in reconstructing basis comes down to what records are available. The best and only way to truly know your basis is correct is to go back to the S election date (or date your first acquired stock in the S corporation) and roll forward from the beginning. Meaning shareholders will need to gather the historical information for the years in which they held the S corporation stock. This historical information will include: all S corporation tax returns (including K-1s), ownership changes, outside stock transactions and details of shareholder loans. If your construction company opened up shop 3 years ago the task isn’t so bad, however if it was incorporated in the 1980’s, you may not have the historical data readily available to perform the necessary calculations.
Although the IRS is not instituting penalties at this time for omitting the basis information from the return, the return may be viewed as deficient because it does not contain sufficient information to allow the IRS to verify the mathematical calculation of the tax liability shown on the return. If a return is considered deficient in this manner, it will not start the running of the statute of limitations for assessment of tax. Additionally, failure to disclose this information when required is a red flag that could put your return under IRS examination.
If you believe you may be in need of a basis study or have questions regarding the above please contact a member of Withum’s Construction Services Team for more information.
Author: Andrew Schoenemann, CPA | firstname.lastname@example.org