Shareholder Basis – Do you have to? Or should you?

By Sandy Sporleder

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Due to recent reports that there has been a high rate of noncompliance, not only has the IRS published a formal letter regarding this issue, but we thought we could help explain the importance of basis letters for shareholders, as well as how and when they should be utilized. We’ll also share six significant benefits for banks that maintain shareholder basis records.

Who and What is Required to Comply

As part of the Tax Cuts & Jobs Act, the IRS added a new requirement (beginning with 2018 tax returns) for shareholders of S corporations, partners in partnerships, and members of LLCs taxed as partnerships. It requires the owners to attach a calculation of their income tax basis to their individual returns. They must comply with this requirement if they:

• Are allocated a loss from Schedule K-1;
• Received a distribution;
• Disposed of S corporation stock or an interest in the partnership during the year; or
• Received a loan repayment from the S corporation or partnership.

In response to the widespread noncompliance following this requirement, the IRS has drafted and published a form letter to send to individuals who have not attached the basis computation to their Schedule E.

Alert for S Corp Bank Shareholders

While we hope you’re not allocating losses to your shareholders, if you’re not, then you’re probably paying your shareholders a distribution. This new requirement likely affects all S Corp bank shareholders.

As an S Corp shareholder your basis changes every year, and the shareholder must update the basis annually – even if none of the events requiring return disclosure occur during the year.

So this begs the questions should you, and/or do you have to?

Q:  Does your bank have an obligation to calculate the shareholder’s basis and to provide It with the K-1?

A: The short answer is no.  The obligation to determine basis, and to disclose the basis in an attachment to the Schedule E included with Form 1040, is the shareholder’s responsibility.  There is no requirement for the entity to maintain those records for the shareholder or to include that information on their S corporation return.  Perhaps the better question is…

Q:  Should your bank provide basis calculations with the Schedules K-1?

A:  In most cases, we believe the answer is yes.  Maintaining basis records has material benefits for the pass-through entity.

We know from experience that shareholders do not always maintain basis records, or understand the information that adjusts basis annually.  Many times, they’re turning to you and asking for this information.

6 Benefits of Maintaining Shareholder Basis Records

  1. Minimizes Time and Cost.  The most obvious benefit is that the time and cost of updating basis as one shareholder or another asks for help is likely to be considerably greater than if the bank simply gathers all of the information once and lets the tax preparer update it automatically each year while preparing the K-1’s.
  2. Improves Accuracy and Diligence.  The bank maintaining basis records will also facilitate a more accurate ownership list, and improve the accuracy of the allocations on the K-1s.  S corporations are exposed to having their S election inadvertently terminated by unreported shareholder actions, especially actions involving trusts and estates.  Maintaining the shareholders’ basis facilitates more thorough annual due diligence to protect the validity of the S election.
  3. Decreases Risk of Error.  Basis will be more accurate, and uniform, if the bank (through its tax preparer) maintains the basis records.  All of the information for the annual adjustment of shareholders’ basis is available on their K-1, but the risk of error increases as the number of shareholders’ increases, and transactions in shares become more common.
  4. Avoids Long-term Negative Impact.  If your bank is anticipating a sale or a merger, knowing the shareholders basis will be very important.  It could impact how you structure the deal and the tax consequences of the sale.
  5. Avoids Deducting Non-Deductible Losses. If a shareholder happens to exhaust basis, the bank can include a statement with the K-1 stating the amount of loss that is not allowable in the current year and will be carried forward.  The statement is much more likely to have the attention of the shareholder’s tax preparer than just the K-1.
  6. Creates Potential for Deduction.  Under the Tax Cuts and Jobs Act, if an individual shareholder pays his/her tax preparer to determine basis, the cost is nondeductible.  If the bank pays to maintain the basis records as part of the annual tax return preparation, it is an ordinary and necessary business expense that will flow through as a deduction on the K-1.

If your bank has not maintained basis records for its shareholders, the fourth quarter is a perfect time for us to assist you with compiling the beginning basis for each shareholders as of the beginning of 2019.

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