S corporations: The challenge of maintaining tax basis schedules

Do you provide tax basis schedules to your shareholders on an annual basis? Alternatively, do your shareholders maintain their own tax basis schedules? If the answer to both questions is “no” and you are an S-corporation bank, your shareholders may encounter an unwelcome surprise. This is because the 2018 tax filing season brought significant changes, including new tax basis reporting requirements.

New tax basis reporting requirements

The IRS made several revisions to the individual income tax return (Form 1040) during the 2018 tax filing season. One of the changes includes a new requirement for S-corporation shareholders to attach a tax basis schedule to their income tax return if any of the following occur:

• A loss is reported on the Schedule K-1.
• A distribution is received.
• Stock is disposed of.
• A loan repayment is made from an S corporation.

Since most S-corporation banks pay quarterly tax distributions to their shareholders (to cover quarterly estimated tax payments), we anticipate that this new requirement will impact most 
S-corporation bank shareholders. Tax basis calculations are cumulative in nature, which means that the shareholder (or the bank) must update tax basis calculations annually, even if none of the events above occur during a given tax year.

Who is responsible for maintaining tax basis?

The requirement to maintain tax basis (and to disclose tax basis on Form 1040) is ultimately the responsibility of the S-corporation shareholder. There is no requirement for the bank to maintain tax basis schedules for its shareholders or to include this information with the Schedule K-1s. Despite this fact, it is generally more advantageous for tax basis to be maintained at the entity level for the following reasons:

• It can be complicated to maintain accurate tax basis schedules, and many shareholders do not understand the information needed to adjust their tax basis schedules annually. Tax basis schedules maintained by the S corporation will generally be more uniform across the shareholder group and more accurate if maintained by the entity’s tax preparer.
• The cost for maintaining tax basis schedules on an ad hoc basis (i.e., as each shareholder seeks assistance from their personal tax advisor) is likely greater than it would be for the entity to maintain the tax basis schedules for all shareholders at once.
• If tax basis schedules are maintained at the entity level, it will facilitate a more formalized due diligence process (regarding ownership changes), which will help to protect the validity of the S-corporation election.
• The professional fees for maintaining tax basis schedules at the entity level are tax deductible, whereas the professional fees incurred by an individual are not tax deductible.

What should we do going forward?

Ultimately, your bank will need to decide whether it wants to help your shareholder group by providing tax basis schedules on an annual basis. 

There is no requirement to do this; however, there are numerous benefits of providing tax basis schedules at the entity level. In addition, there are indications that shareholder tax basis calculations might become a corporate level responsibility in the future. 

For example, partnerships are now required to track tax basis for their partners. It is conceivable that this requirement may be extended to S corporations.

There are numerous challenges that come from maintaining tax basis schedules. Since most banks have been profitable in recent years, and shareholders haven’t had to worry about tax basis limitations, it is likely that shareholders have not been maintaining their own tax basis records. 

Thus, the decision to provide tax basis schedules at the corporate level will require going through historic tax records (potentially multiple tax years) in order to calculate the cumulative tax basis adjustments. It will also be necessary to review stock ownership changes over this same time period (e.g., stock sales, stock redemptions, gifts between shareholders, etc.).

Wipfli can help your bank to maintain tax basis schedules for your shareholders. Please contact us if you would like assistance with this new tax basis reporting requirement.