This article will help you generate shareholder basis statements that you can provide to shareholders with their Schedule K-1. For information about completing Form 7203, which is produced and filed with the individual 1040, see here.
Click on a question below to view answers to frequently asked questions about the basis limitation:
Table of contents:
What is basis limitation?
- The basis limitation is a limitation on the losses and deductions that a partner in a Partnership or a shareholder in an S Corporation can deduct.
- The basis limits are the first of three limitations that are applied to Schedule K-1 losses and deductions.
- After the basis limits are applied, the At-Risk limits (Form 6198) are applied. If losses are allowed by the basis and at-risk limits, then the passive limits (Form 8582) are applied, if applicable.
- The basis and at-risk limits are similar, in that the limits are applied separately to each K-1 input screen. Losses may be fully allowed on one activity, while another activity may have all of it's losses limited. The passive limits are applied by aggregating all passive activities together.
Is the requirement to attach a statement for S Corporation loss activities new?
No. The Schedule E instructions have had that requirement at least as far back as 1992.
Does the IRS have a form or instructions for calculating the basis limitation?
Starting in tax year 2021, Form 7203 is used to figure shareholder basis. The IRS doesn’t provide a specific form for tracking partner basis.
How is the basis limitation computed?
The starting point for the basis limitation is adjusted basis at the beginning of year. The following adjustments are made to arrive at the adjusted basis used in applying the basis limitation:
- Adjusted basis is increased by current income from the activity, additional amounts invested in the activity, and depletion in excess of the oil and gas property basis.
- Additionally, for partners, the adjusted basis is increased by their share of the partnership's loans. This is not the case for shareholders. Because the S Corporation is a corporation, it is a distinct legal entity separate from the shareholder, so the shareholder does not increase his or her basis by their share of liabilities. The shareholder only increases basis by the loans they make directly to the corporation. This is why there is separate input for loan information in the S Corporation screen, but not the partnership screen. The partner's share of liabilities should be input into the Adjusted basis at beginning of year field.
- Distributions decreases in partner's share of partnership debt, or repayments received by shareholders.
- If the current year disallowed loss, plus prior year disallowed losses, exceeds the basis computed, some of the loss is disallowed. Any disallowed loss is carried to the following year return and is treated as incurred in the following tax year.
- For partners, the allowed loss is allocated pro-rata to each loss or deduction (Ordinary, 1231, capital gains/losses, 179 expense, etc). For shareholders, there are ordering rules. Nondeductible expenses and depletion are allowed in full first, unless the shareholder has filed an election to do otherwise. This election can be triggered in the second Elections screen under the Other section, by entering the S Corporation name or number in S-Corporation name or number. Additionally, an entry of "1" needs to be made in 1 = Deduct losses before nondeductible expenses and depletion, 2 = prorata (Income > S-Corp Info (1120S K-1) > Basis Limitation).
Is basis the same as partner capital shown on Schedule K-1?
No. According to the Partner's Instructions for Schedule K-1, the basis schedule represents outside basis while the capital account represents inside basis. These can differ, even when the partnership maintains its books and records on a tax basis. One way this difference can occur is when a partner buys his partnership interest from another partner, since the purchase price becomes the starting point for his outside basis.
Can basis ever become negative?
No. Per Internal Revenue code section 704(a)(2) and 1367(a)(2) basis can never fall below zero. Negative basis should not be input in Adjusted basis at beginning of year.
What happens when distributions exceed a shareholder's stock basis?
Per Internal Revenue code section 1368, the treatment of a distribution in excess of stock basis depends upon whether or not the S-Corporation has any earnings or profits from when it was a C Corporation.
If there was no earnings and profits, then any amount distributed in excess of stock basis is considered gain from the sale or exchange of property (IRC. 1368(b)(2)).
If the S-Corporation had earnings and profits from when it was a Corporation, then, per Internal Revenue Code section 1368(c) the following rules apply:
A. The portion of the distribution that does not exceed the accumulated adjustments account is treated as a gain from the sale or exchange of property.
B. The portion of the distribution remaining after step A (above) is treated as a dividend to the extent it does not exceed accumulated earnings and profits of the S-Corporation.
C. Any distribution remaining after applying the two steps above is treated as gain from the sale or exchange of property.
To enter any gain determined by the above rules, enter a disposition in Income > Schedule D/4797/etc. Additionally, enter the amount of the gain in Other current year increases to basis (Income > S-Corp Info (1120S K-1) > Basis Limitation).
What happens when distributions exceed partner basis?
Distributions in excess of basis results in gain (IRC. 731(a)(1)). Any gain recognized is considered gain from the sale of exchange of the partnership interest. See Internal revenue code section 731 for how to determine the character of the gain.
How is income used to restore shareholder debt basis computed?
The program computes this amount in accordance with Internal Revenue code section 1367(b)(2)(B) which states that any net increase to basis increases debt basis before stock basis. This "Net increase" is the amount by which current year income and other increases to basis exceed current and prior year losses, and other decreases to basis.
The loss from Schedule K-1 has enough basis to be allowed. Why isn't it showing on Schedule E page 2?
Most likely, the loss is being limited by either the at-risk or passive limits. To see if the loss is disallowed by at-risk, please view Form 6198. To see if the loss is disallowed by passive, view Form 8582, or if it is a publicly traded partnership, view the Passive worksheets.
My basis is zero. Why are losses being allowed?
Most likely, the loss being allowed is an at-risk or a passive carryover from a prior year. At-risk and passive carryovers are not limited by basis, since those losses have been allowed by the basis limits in a prior year. The limits are applied in order (basis, at-risk, then passive), once a loss has been allowed by a limitation, that limitation never gets reapplied.
Why aren't the AMT adjustments I entered in the K-1 input screen appearing on Form 6251, lines 16 or 17?
When the basis limitations are applied to a K-1 input screen activity, the AMT adjustments are used in computing an Alternative Minimum Tax version of the basis limitations. The AMT adjusted gain or depreciation adjustment will either be reported on line 19 as a loss adjustment, or if the passive limits are being applied, on line 18 as a passive adjustment. If all loss is disallowed, the current year AMT adjustments will be reflected in a different AMT loss carryover (eg. AMT basis carryover may be higher than regular basis carryover).