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S corporation basis reporting changes

The IRS has created new Form 7203 to track and report basis year over year.

By Mike Giangrande, J.D., LL.M.
Federal Tax Editor

Starting with the 2021 tax year, the IRS has added new Form 7203, S Corporation Shareholder Stock and Debt Basis Limitation. The new form replaces the worksheet used for figuring an S corporation shareholder’s stock and debt basis that was previously contained in the Schedule K-1 instructions.

The new Form 7203 contains three parts:

• Part I: Shareholder Stock Basis;
• Part II: Shareholder Debt Basis; and
• Part III: Shareholder Allowable Loss and Deduction Items.

As of publication, Form 7203 and its instructions had not been finalized. The most recent version can be found at the following links:

Form 7203: www.irs.gov/pub/irs-dft/f7203–dft.pdf

Form 7203 instructions: www.irs.gov/pub/irs-dft/i7203–dft.pdf

Stock blocks

When an S corporation shareholder has a different basis in different blocks of stock, passthrough items are generally allocated pro rata to all shares, regardless of their different basis. If there is a partial stock sale or partial redemption, taxpayers can file more than one Form 7203 for each block of stock and track basis separately.

Tracking stock blocks with differing basis separately can be beneficial for a shareholder who plans on disposing portions of their S corporation stock holdings.

Example of tracking stock blocks: John owns two blocks of S corporation stock in Company A. He purchased block 1 on January 22, 2021, consisting of 100 shares for $10,000 and block 2, also consisting of 100 shares, for $20,000 on September 12, 2021. Using Form 7203, John can track the basis of each stock block separately directly on his income tax return. In 2022, John decides to sell 50 shares of Company A stock. John can choose to sell only block 2 shares that have a higher basis. It’s important to note that taxpayers could have always tracked their S corporation stock blocks separately, but Form 7203 makes tracking an easier process directly on the income tax return. It also makes it easier for a new tax professional to pick up where the previous tax professional left off instead of having to request basis tracking information from someone your client has since fired.

Distributions in excess of basis

Prior to 2021, when a taxpayer calculated distributions in excess of basis on the basis worksheet from the Schedule K-1 instructions, the resulting capital gain did not always make its way onto Schedule D. The new Form 7203 calculates distributions in excess of basis directly on the face of the form, which will carry automatically to Schedule D, Capital Gains and Losses, as capital gain.

Debt basis

Another notable aspect of the new Form 7203 is that taxpayers must report and track each loan a shareholder makes to their S corporation separately and must indicate whether the debt is evidenced by a formal note or is an open account debt. The form also tracks whether loan repayments give rise to reportable gain to the shareholder.

Whether debt is evidenced by a formal note or is an open account debt is important because the character of any gain on repayments is dependent on this determination. Gain on debt repayments evidenced by a formal note result in capital gain and should be reported on Form 8949, Sales and Other Dispositions of Capital Assets, and Schedule D. Gain on open account debt results in ordinary income and should be reported on Form 4797, Sale of Business Property.

Who must file Form 7203?

The same filing requirements for Form 7203 apply to taxpayers who previously had to attach a basis schedule to their individual income tax return. These are S corporation shareholders who:

1. Are claiming a deduction for their share of aggregate loss from an S corporation (including an aggregate loss not allowed in the prior year because of basis limitations);
2. Received a nondividend distribution from their S corporation;
3. Disposed of stock in an S corporation (whether or not gain is recognized); or
4. Received a loan repayment from an S corporation.

Practice Pointer Despite the four requirements above detailing which taxpayers must include Form 7203 with their income tax return, tax professionals should prepare Form 7203 even in years when it isn’t required to ensure consistent basis reporting year over year.

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