Form 7203 for 2022: Not much has changed in the form’s second year
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Form 7203, S Corporation Shareholder Stock and Debt Basis Limitations, replaces a three-part worksheet for figuring a shareholder’s stock and debt basis that used to be found in the Shareholder’s Instructions for Schedule K-1 (Form 1120-S). The IRS introduced Form 7203 in 2021 and appears to be changing it only slightly in draft forms and instructions for 2022.
S corporation shareholder’s losses are limited by stock and debt basis 2022
An S corporation’s losses usually flow through to its shareholders rather than being taken into account for tax purposes by the corporation itself. Therefore, each shareholder will need (and probably want) to determine how much of the corporation’s losses the shareholder can deduct on his or her own tax return.
But just because some of the S corporation’s loss is allocated to a shareholder, that does not mean the shareholder can deduct his or her whole share. The shareholder must have enough basis in the S corporation’s stock and/or debt to absorb his or her share of the corporation’s loss.
A shareholder’s initial basis in the stock is likely the cost of the stock when the shareholder acquired it. However, this basis has probably gone up and down while the shareholder held the stock, increasing as the corporation passed through income and gain, and decreasing when the corporation passed through losses and distributions.
Similarly, initial basis in a debt the corporation owes the shareholder also may increase and decrease with the corporation’s payments, loss deductions, and nondeductible expenses.
Shareholders used worksheets to track basis before 2021
For tax years before 2021, the instructions for Schedule K-1 (Form 1120-S) contained a three-part worksheet that shareholders could use to track their stock bases year by year. As a worksheet in the instructions, it was not something shareholders needed to file.
The worksheet guided a shareholder through the detailed process of:
- Increasing basis each year for all income reported on the Schedule K-1 provided by the S corporation, and then
- Decreasing basis (but not below zero) by the amount of property and cash distributions reported on Schedule K-1,
- Decreasing basis by nondeductible expenses and, finally,
- Decreasing basis by losses and deductions reported on Schedule K-1.
Form 7203 replaced worksheet in 2021
Beginning with the 2021 tax year, Form 7203 replaced the worksheet. However, the form requires the shareholder to complete the same basic steps in the same order as the worksheet.
The IRS recommends that shareholders complete (and hold onto) Form 7203 even in years in which they are not required to file it, simply to keep track of their bases.
But a shareholder must file Form 7203 if he or she:
- Is claiming a deduction for the shareholder's share of the S corporation’s loss,
- Received a distribution from the S corporation that was not a dividend,
- Disposed of stock of the S corporation, or
- Received a loan repayment from the S corporation.
Draft Form 7203 for 2022 includes few changes
The draft Form 7203 for tax year 2022 makes only two changes to the 2021 form:
- The draft form includes a new Item D. A taxpayer will need to check a box (or boxes) to show how he or she acquired the stock in the S corporation. The draft instructions say that the shareholder should check “Other” if she acquired he or she acquired the stock in some other way other than by purchasing it, inheriting it, receiving it as a gift, or obtaining it as an original shareholder.
- Item E on the draft form asks a taxpayer-shareholder whether he or she has an election in effect for the tax year to reduce the shareholder's basis for the share of S corporation losses and deductions before reducing basis for nondeductible expenses. In other words, the election reverses steps (3) and (4) in the process of reducing basis on the pre-2021 worksheet. The shareholder may want to consider making the election to avoid deferring his or her deduction for losses if she does not have sufficient basis remaining after reducing it for nondeductible expenses.
The final version of the 2022 Form 7203 is scheduled to be released in December.