Since the sweeping changes in the Tax Cuts and Jobs Act of 2017 went into effect, many businesses have rethought how they are structured. S Corporations have a certain appeal and may be a good fit for some. Today, we’ll help you understand the importance of tracking your basis in an S Corporation.
When investing in an S Corporation, it is important to know your basis. According to the Internal Revenue Service, basis is defined as your capital investment in a property for tax purposes. It is used to figure out your depreciation, amortization, depletion, as well as gain or loss on the sale, exchange and disposition of the property. As a shareholder in an S Corporation, you receive a K-1 that reflects current-year income or loss, and deductions. The K-1 that you receive does not reflect your current-year taxable distributions. This is because the taxable amount of your distribution depends on your basis.
Unfortunately, it is the responsibility of the individual shareholder, not the corporation, to keep track of basis. S corporations are subject to single-level taxation. An S Corporation generally does not pay taxes on the income it generates; rather the income is allocated to the shareholders and taxed at the individual level. Shareholders must have adequate stock and debt basis in order to take losses or deductions that flow-through from the S Corporation.
Why is knowing your basis important? Computing your basis in an investment can be boring and tedious or it can be as easy as looking at your checking account.
On February 6, 2019, the IRS released clarification on line 28, column (e), of Schedule E (Form 1040), which highlights a new box that was added to Schedule E related to shareholder basis, that says:
“As stated in Part II of the Schedule E (Form 1040), a taxpayer who owns an interest in an S corporation and reports a loss, receives a distribution, disposes of stock, or receives a loan repayment from the S corporation must check a corresponding box under line 28, column (e), and attach a computation detailing their S corporation basis. The discussion about basis rules for S corporations in the Instructions for Schedule E (Form 1040) for Parts II and III does not limit or modify this requirement.”
As we are half-way through the year, it is recommended that shareholders review their basis as part of tax planning to know whether losses can be deducted, suspended and/or carried forward, as well as to determine the taxability of distributions.
As tax advisors, we are here to help you break down the complicated rules of calculating shareholder basis. Let’s take a look!
Mike McVay, Accountant * 850-725-5696 * Mike@MikeMcvay.com
McVay Business Services - Accounting & Tax Services Pensacola, FL
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Mike McVay, Accountant -Experienced IRS Tax Resolution Specialist