If there’s one issue in tax that tax professionals have trouble explaining to clients it’s basis. Your basis in an entity is, generally, the total of your investment in an entity plus income it generated less any distributions from it. If you’re an investor in a business, you can only take losses up to the amount of your basis. Sounds simple, right?
So let’s say you invest in an S-Corp, “Losing Money, Inc.” Unfortunately, it’s name matches what’s happened year after year. You invested $10,000 years ago, and each year your share of the loss has been $3,000. It’s year four of your ownership, and you get the K-1 showing the (as usual) $3,000 loss. Your tax professional tells you, “I’m sorry, but you’re only getting $1,000 of the $3,000 loss–you used up your basis.”
The IRS has been battling this issue for a number of years. Owners of businesses are supposed to keep basis statements. Most reputable tax professionals prepare basis statements for the partnerships and S-Corporations that they prepare returns for. It remains, though, the responsibility of the owner to keep track of the basis. The IRS wised up a couple of years ago and added Form 7203 (S-Corporation Basis Statement). As to who must file the form:
Who Must File
Form 7203 is filed by S corporation shareholders who:
- Are claiming a deduction for their share of an aggregate loss from an S corporation (including an aggregate loss not allowed last year because of basis limitations),
- Received a non-dividend distribution from an S corporation,
- Disposed of stock in an S corporation (whether or not gain is recognized), or
- Received a loan repayment from an S corporation.
That’s pretty clear, right? And that’s most S-Corporation owners.
We have a new client this year, and she sold the assets of her business the prior year. She’s taking funds out of the business (it had a small loss), so there was a distribution. The client’s long-time tax professional (he prepares the S-Corporation returns) told me that Form 7203 wasn’t required. I noted it is (there’s both a loss and a $150,000 non-dividend distribution). That’s two of the four reasons you are required to file the form. We’re still waiting on the basis information (as I write this), and there’s time for her individual return to be timely filed. However, until I obtain basis information that return is not going to be filed.
Of course, some individuals may simply ignore attaching the basis statement and play ‘audit roulette.’ That’s something else I can never advise. But if you want to enjoy the Bozo side of life, just keep ignoring your basis and take your loss year after year after year.
Tags: BozoTaxTips