Archive for the ‘S Corporation’ Category

Bozo Tax Tip #3: We Don’t Need No Stinkin’ Basis

Wednesday, April 12th, 2023

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.

Contributing to the IRS’s Paper Backlog

Friday, May 20th, 2022

A client of ours has filed Form 2553 three times to elect S-Corporation status.  The first time, his attorney sent the form to the IRS.  The second time, my client mailed the form (right before the pandemic began).  The third time, I faxed the form (now 13 months ago).  As of today, the IRS has not processed the request.  On Twitter, a fellow tax professional noted it took 22 months for his client’s Form 2553 to be processed.

Yesterday, I called the IRS up to see if the S-Corporation election had been processed (I have a Power of Attorney for the entity).  It has not been.  The IRS agent told me that the 2020 tax return for the client also had not been processed, and it should be resent along with another copy of the Form 2553.

I checked with my client; he timely mailed the 2020 tax return and has proof of receipt (he sent it certified mail, return receipt requested).  We decided not to resend the tax return because it’s currently taking the IRS months to open their mail.  The IRS Agent told me, “If it had been sent in September it would show up in our system by now.”  Based on the testimony of IRS Taxpayer Advocate Erin Collins, that’s simply not the case.  Until the return has been processed, it doesn’t show in the IRS computer system at all.  I decided not to argue with the IRS Agent I spoke to, but he might want to read his own website:

The IRS is opening mail within normal timeframes and all paper and electronic individual refund returns received prior to April 2021 have been processed if the return had no errors or did not require further review.

As of May 6, 2022, we had 9.8 million unprocessed individual returns which include returns received before 2022, and new tax year 2021 returns. Of these, 2.6 million returns require error correction or other special handling, and 7.2 million are paper returns waiting to be reviewed and processed.  [emphasis added]

This is straight from the IRS’s “Operations Page During Covid-19,” and it was updated on May 17, 2022.  It is extremely likely (if not certain) that my client’s 2020 S-Corporation return is simply sitting in a bin in Ogden, Utah waiting for its turn in the queue.  Sending a second return would only cause other problems.  Given current IRS processing times for paper returns–about one year–if the return hasn’t been processed by late October we’ll check with the IRS and perhaps then send another copy of the return.

In any case, my client will be heading to the Post Office this morning to mail Form 2553 to the IRS.  I’m not holding my breath on it being processed quickly, but miracles do occur.

There’s No Basis for that Argument

Wednesday, August 25th, 2021

Yesterday, TIGTA release a report, “Efforts to Address the Compliance Risk of Underreporting of S Corporation Officers’ Compensation Are Increasing, but More Action Can Be Taken.”  From the report:

TIGTA’s analysis of all S corporation returns received between Processing Years 2016 through 2018 identified 266,095 returns with profits greater than $100,000, a single shareholder, and no officer’s compensation claimed that were not selected for a field examination.

S-Corporation officers (and owners who own 2% or more of the entity) are required to be paid a “reasonable” compensation.  Clearly, $0 isn’t reasonable for a business profiting $100,000 per year.  (There could be an exception for a company using that profit to pay back a loan that it took during the time it was unprofitable.)  I’ve seen prospective S-Corporation clients with large profits who are taking salaries of $20,000 a year; again, this is clearly unreasonable compensation.  TIGTA urged the IRS to do more, but the IRS basically disagreed with the recommendations.  I learned by reading the report that the IRS is conducting another Compliance Initiative Project to look at officer’s compensation (this began last August).

Another S-Corporation issue is basis.  One of the rules about deducting losses is you must have basis in the entity.  You can get basis in an S-Corporation by contributing capital, previous net income, and/or loaning the company money.  But let’s say I have an S-Corporation, and I give you 10% of the stock as part of your employment package.  Further, let’s assume that the business loses $100,000 (so your share of the loss is $10,000).  What can you deduct on your personal tax return?  Generally, nothing–you have no basis in the entity.

A couple of years ago the IRS tried to improve compliance here: Basis statements are required to be attached to personal tax returns in this situation.  It appears that isn’t working well (probably a combination of individuals ignoring the rule and differing forms for a basis statement).  In July the IRS published a request for comments about a new Form 7203 in the Federal Register.  The IRS is requesting comments:

Comments are invited on: (a) Whether the collection of information is necessary for the proper performance of the functions of the agency, including whether the information shall have practical utility; (b) the accuracy of the agency’s estimate of the burden of the collection of information; (c) ways to enhance the quality, utility, and clarity of the information to be collected; (d) ways to minimize the burden of the collection of information on respondents, including through the use of automated collection techniques or other forms of information technology; and (e) estimates of capital or start-up costs and costs of operation, maintenance, and purchase of services to provide information.

It appears the IRS wants to develop a standardized form (Form 7203) that S-Corporation owners must use to note their basis.  I did a search to see if there’s even a draft of Form 7203 anywhere, but there’s none.  It’s clear that the IRS at least here recognizes there’s an issue and is looking at means of resolving it.  If you wish to comment on the proposal, you have until September 17.

If you’re an S-Corporation owner and haven’t been taking ‘reasonable’ compensation, today’s a good day to start.  And if you’re an S-Corporation owner who hasn’t been tracking basis, you really need to do so.

Funding an S-Corp from an S-Corp: Distribute, Don’t Loan

Thursday, June 7th, 2012

Joe Kristan has an excellent update that is a must-read for owners of multiple S-Corporations. The Tax Court validated a traditional S-Corporation planning technique: You can distribute basis from one S-Corporation to another. There are some caveats (aren’t there always?), and the paperwork is vital, but this is a technique that can work.