Form 7203 and S Corp Basis: Who Files and the Yearly Worksheet

Do I have to file Form 7203 with my S corp K-1?

Not for every K-1. You file Form 7203 with your own return, not the company's, when in the year you:

• claim a deduction for your share of an S corporation's losses and deductions (the instructions say "aggregate loss"), including a loss an earlier year's basis could not cover;
• received a distribution that was not a dividend (K-1 box 16, code D);
• disposed of stock, whether or not there was a gain; or
• received a loan repayment from the company (K-1 box 16, code E).

If none of those happened, the form is not required for that year. The instructions do not say whether a K-1 with net income and a separately stated deduction, such as a charitable gift, counts. The IRS suggests completing and keeping the form even when it is not required, so basis carries forward without gaps. Form 7203 replaced the three-part basis worksheet that used to sit in the K-1 instructions. If you file jointly and both spouses received a K-1, each completes a separate form (Form 7203 instructions).

Rebuilding your basis is not simple when:

• basis was never tracked, or earlier K-1s are missing or do not match the bank and the company's books;
• you took distributions or deducted losses in years with no Form 7203;
• you put money in, or paid company bills, and the books do not show how it was treated;
• you bought your shares from another owner, or got them by gift, inheritance, or when an LLC became an S corporation;
• a sale or buyout is coming.

Gather first: every K-1 and filed return since you first held shares, the stock purchase record, bank records of money you put in or took out, loan notes, and the company's balance sheet and distribution accounts.

Tax software asks for your beginning stock basis. Without last year's ending figure, typing zero or the company's equity line is a guess that carries into every later year. The Form 7203 instructions do not say what follows when the form was required in an earlier year and left off. What matters is whether the missing basis changed what you reported: a loss deducted, or a distribution treated as tax-free, without enough basis behind it. Rebuilding the years in order, then deciding whether any filed return needs correcting, is the part to bring a professional in on (corporate tax help).

What is S corp shareholder basis, and why does it matter?

Basis is your tax cost in the company, kept as two figures: stock basis (what you paid or put in for the shares, adjusted every year) and debt basis (money you lent the company that it still owes you). The company does not work either one out. The K-1 gives inputs, and you carry the running total from year to year, so one missing year breaks every later year (IRS: stock and debt basis).

Sources: IRS: stock and debt basis; 26 U.S.C. 1366(d).

A loss on the K-1 is not yet a deduction. The company reports its income or loss without reference to your basis, at-risk or passive limits; those are applied on your own return (Instructions for Form 1120-S). For how S corporation income, distributions and filing work overall, see how S corporations are taxed.

What is my starting stock basis?

Starting basis is what you paid or put in, and the rule depends on how you got the shares (Form 7203 instructions, line 2).

If you hold shares bought at different times, each purchase is a separate block with its own basis. The year's adjustments are spread across all shares in proportion, whatever each block cost, and a partial sale or redemption calls for two forms, one at the date of sale and one at year end (Form 7203 instructions, Item C and line 13).

How do I figure S corp stock basis each year, in order? A worksheet

Adjust stock basis at the end of the company's tax year in this order: add income, subtract distributions, subtract nondeductible expenses, then subtract losses and deductions. Basis never goes below zero (IRS: stock and debt basis; 26 CFR 1.1367-1(f)). This table is the yearly worksheet; the line numbers are those of Form 7203 (Rev. December 2022), so check them against the revision your return uses.

Rules to watch:

• Income is added before distributions, so the year's K-1 income helps cover that year's distributions. A loss comes last, so it does not (26 U.S.C. 1368(d)).
• Taxable income raises basis only to the extent you included it in gross income on your return, as adjusted in any later redetermination (26 U.S.C. 1367(b)(1)). K-1 income left off an earlier return may leave a gap in basis until it is reported.
• Dividends on Form 1099-DIV, paid from C corporation earnings, are not in box 16, code D, and do not reduce stock basis. A company can have such earnings if it was once a C corporation or took them over in a merger or reorganization (Form 7203 instructions, line 6; IRS: stock and debt basis).
• You may elect to subtract losses before nondeductible expenses, so that nondeductible expenses above your stock and debt basis carry forward instead of being lost. It is made by a statement attached to your timely filed original or amended return and applies to that company for all future years unless the IRS agrees to revoke it (Form 7203 instructions; 26 CFR 1.1367-1(g)).
• If the company gave property to charity, your stock basis falls by your share of the property's adjusted basis, not the larger deduction, and the deduction above that basis is not held back by the basis limit. The K-1 statement shows both amounts; other charitable limits still apply (26 U.S.C. 1367(a)(2); 26 U.S.C. 1366(d)(4); K-1 instructions, box 12).
• Rarer reductions also belong on the form: oil and gas depletion (line 8b), credits that reduce basis (line 8c) and tax paid on undistributed capital gains (K-1 box 13, code H; the IRS says Part III, line 45) (Form 7203 instructions; IRS: box 13, code H on Form 7203).

Which numbers come from my K-1, and which from the company's books?

The K-1 gives each year's income, expenses, distributions and loss items. It does not give your starting basis, your debt basis or your suspended losses (IRS: stock and debt basis). The rest comes from your own records, checked against the company's books.

The books are most useful for the two things the K-1 cannot prove: that a distribution or repayment really was paid on the date and in the amount shown, and that money you say you put in really went in.

The books and the K-1 can disagree when money that left the company for you was booked as something else: the company paying your personal bills, owner "draws" entered as expenses, or transfers to you booked as a loan with no note behind it. Reconcile the two before the running total means anything. How each case is treated is in S corporation paying personal expenses and recording S corporation distributions.

Can I use the equity on the company's balance sheet as my basis?

No. Retained earnings, equity and the accumulated adjustments account (AAA, on Schedule M-2) are the company's records. Basis is yours, built from your cost plus K-1 items each year. The books confirm the inputs; they do not replace the running total.

They differ for concrete reasons:

• The AAA leaves out tax-exempt income and can go negative, while stock basis includes tax-exempt income and cannot go below zero (26 U.S.C. 1368(e); Instructions for Form 1120-S).
• What you paid another owner for shares is your cost. It never appears in the company's equity.
• Basis is figured per shareholder, and per block of stock, while the balance sheet shows one total for everyone.

For the bookkeeping side, see S corporation bookkeeping.

What counts as debt basis, and what does not?

Debt basis is the balance of money you lent the company directly, reduced by losses and later restored. Only a real loan from you to the company counts, and whether a loan is real depends on all the facts and circumstances (26 CFR 1.1366-2(a)(2)).

Distributions you receive never reduce loan basis. Sources: Form 7203 instructions; 26 CFR 1.1366-2(a)(2).

Debt basis moves in two ways. Losses larger than your stock basis reduce it, and so do nondeductible expenses larger than your stock basis, down to zero. Later, a net increase in your basis (income above losses, distributions and the like) restores it first, up to the loan balance, before any of it adds to stock basis (26 U.S.C. 1367(b)(2)).

Timing matters. A loan counts toward a year's losses only if you still hold it at the company's year end, or just before you give up all your shares. A loan repaid or forgiven earlier adds no room for them, and restoration reaches only loans held at the start of the year (26 CFR 1.1366-2(a)(4)(ii); 26 CFR 1.1367-2(b)(1), (c)(1)). Track repayments as well as new advances.

Form 7203, Part II, tracks each written note in its own column. Advances with no written note form one combined "open account" balance. Once that balance is above $25,000 at the close of the company's year, it is treated as a written note from the next year (Form 7203 instructions; 26 CFR 1.1367-2(a)(2)). If a loan's basis was reduced, part or all of a repayment can be taxable. How to document and book a loan, and how a repayment is taxed, is in shareholder loans to an S corporation.

Can I treat bills I paid for the company as a capital contribution?

Only if the facts and records show it. Basis comes from money or property you put into the company as capital, from shares you bought, or from a real loan to the company. Paying a company bill from your own pocket does not add basis by itself.

• Capital: cash or property you contribute, or shares you buy, goes on Form 7203, line 2. Loans are excluded from that line (Form 7203 instructions).
• Loan: a real loan from you adds debt basis, as above.
• A bill you paid personally: the facts decide, and the Form 7203 instructions give no rule for it. Records that may matter include how you and the company treated the payment when it was made, any note, and any repayment. For the books, see expenses you paid and were never reimbursed. If the money came from family abroad, see money from family abroad in your business books.
• The label is not enough. The IRS says to consider whether a shareholder claiming a large contribution or loan had the financial means to make it (IRS: stock and debt basis).
• Timing: stock basis is generally figured at the end of the company's year, so only what was put in by then counts for that year. In the year you dispose of shares, the adjustments are made immediately before the disposition, so money put in after a sale adds nothing (Form 7203 instructions; 26 CFR 1.1367-1(d)(1)).

What happens to a loss or a distribution bigger than my basis?

A loss larger than your stock and debt basis is not lost. The part you cannot deduct carries forward without limit, keeps its type (ordinary, capital and so on), and is treated as incurred by the company in the next year (26 U.S.C. 1366(d)(2); 26 CFR 1.1366-2(a)(3)).

• Stock basis absorbs the loss first, then debt basis. When there are several kinds of loss, the allowed amount is shared among them in proportion to size (Form 7203 instructions, Part III).
• The carryover is deductible only as basis is restored, by income or by new capital or loans.
• The K-1 shows only the current year's items, so Form 7203, Part III, column (e) is your record of the carryover.
• The carryover is personal to you. It does not pass to a buyer, and it is permanently disallowed once you transfer all your stock, except for a transfer between spouses or incident to divorce (26 CFR 1.1366-2(a)(6)). See selling or redeeming shares before a sale.
• If the company stops being an S corporation, a loss disallowed for its last S year can be deducted up to your stock basis at the end of the post-termination transition period, which is the later of one year after the last S year or the due date, with extensions, of that year's Form 1120-S, or 120 days after a determination that the election ended in an earlier year. The 120-day window that opens when an audit adjusts S-year items does not apply to these losses. The excess is permanently disallowed (26 U.S.C. 1366(d)(3); 26 U.S.C. 1377(b); 26 CFR 1.1366-2(b)).

In a company with no accumulated earnings and profits from C corporation years, a distribution larger than your stock basis is taxed as gain from selling the stock, and the gain does not raise basis (26 U.S.C. 1368(b); Form 7203 instructions, line 6). How it is reported, and how to fix past years, is in distributions in excess of basis.

What comes after basis: the at-risk and passive loss limits?

A loss that passes the basis test still has to pass three more limits, in this order: at-risk, passive activity, then excess business loss (IRS: stock and debt basis; K-1 instructions).

Basis and at-risk are different tests. The K-1 instructions say you are generally not at risk for stock or loan basis funded from a source covered by nonrecourse debt (debt no one is personally liable to repay) or protected against loss by a guarantee, stop-loss agreement or similar arrangement (K-1 instructions; Form 6198 instructions).

A loss blocked by the at-risk or passive test carries forward under that test's own rules (K-1 instructions; Form 8582 instructions), separately from the basis carryover. What counts as material participation is in business losses.

What records should I keep every year, even when Form 7203 is not required?

Keep the papers that rebuild basis from the first day, because the first year affects every later one, including the year you sell. The Form 7203 instructions say to keep records for as long as their contents may matter in administering any federal tax law.

• Each K-1 with every attached statement, and each return you filed, since K-1 income raises basis only to the extent your return, as filed or later adjusted, reported it.
• A completed Form 7203, or your own worksheet, showing ending stock and debt basis for each year.
• The stock purchase agreement, contribution papers and any share transfer record.
• Bank records of every transfer between you and the company, marked as capital, loan, distribution or repayment, and proof of where the money you put in came from.
• Every loan note, and the year-end balance of any advances with no note.
• Invoices and proof of payment for any company bill you paid personally, with what you and the company agreed.

Example

These examples are illustrative; all figures are in US dollars and ignore the at-risk and passive limits.

Stock basis over two years

A shareholder paid $20,000 for all the shares before Year 1 began.

Year 1 ending basis is the Year 2 starting basis on line 1. Form 7203 is required both years because of the distributions.

A loss bigger than stock basis, with a note

A shareholder has $25,000 of stock basis and a written note for $15,000 that she lent the company. In Year 1 the K-1 shows a $60,000 loss. Stock basis absorbs $25,000 and debt basis absorbs $15,000, so $40,000 is deductible now and $20,000 carries forward. Both bases are now zero.

In Year 2 the K-1 shows $30,000 of income, and there are no distributions or loan repayments. The $20,000 carryover is deductible. The remaining net increase of $10,000 restores the note's basis before it adds to stock basis. Stock basis ends at $0 and debt basis at $10,000.

A guaranteed bank loan

An owner co-signs a $50,000 bank loan to the company. She has no debt basis from it. The company misses payments and in Year 1 she pays the bank $12,000 under the guarantee. Her debt basis can rise by that $12,000, the amount she actually paid, if the bank loan is real debt of the company. It counts from the year she pays.

Different for you?

• Basis was never tracked, and you took distributions or deducted losses in earlier years: the first year affects every later year, so earlier figures may differ from what was reported. Whether past returns or Form 7203 filings need correcting depends on the K-1s and records. See distributions in excess of basis for the shortfall case, and corporate tax help to rebuild each year. If the books for those years are missing or do not match the K-1s, see bookkeeping help to catch them up.
• A sale, buyout or redemption is coming: basis sets your gain, and unused losses can be lost. Income and loss are split by the days you owned shares, so a mid-year sale changes how much of the year's income or loss is yours. If you sell all your shares, the company and every affected shareholder can elect to close the books at the sale date instead (26 U.S.C. 1377(a)). Basis is worth settling before a price is agreed; see selling or redeeming shares and corporate tax help with the sale.
• Your distributions already exceed your basis, or the company was once a C corporation or took over a C corporation's earnings: see distributions in excess of basis.
• Your LLC became an S corporation, or you got the shares by gift or inheritance: the starting basis depends on asset values, liabilities and cost records. Get corporate tax help to settle your starting basis.
• You lent the company money, or co-signed its debt: see shareholder loans to an S corporation.
• You paid company bills yourself and were never repaid: see expenses you paid and were never reimbursed.
• Your K-1 shows income but you received no cash: see pass-through income without a distribution.
• The company's books are behind, or its distribution and loan accounts do not match the K-1: see S corporation catch-up books and S corporation bookkeeping, or get bookkeeping help.
• The company's return or your K-1 is wrong: see correcting a filed business return.
• You own the shares and live in Canada or another country: see US S corporation owner in Canada.