According to a report issued by the U.S. Department of Treasury on September 7, 2021, the difference between taxes owed by taxpayers and taxes collected by the Internal Revenue Service, also known as the “tax gap”, totaled around $600 billion (about $1,800 per person in the US) annually.
To address this collection gap, the IRS has requested additional funding from Congress to increase their staffing and upgrade their computer systems. The IRS believes these actions will enhance their ability to identify noncompliant returns for audit with a view to increasing collections and helping bridge the tax gap.
One of the current actions that the IRS is taking to address noncompliance is placing an increased focus on the major areas where the taxpayers have understated their tax liability. One such identified area of interest involves taxpayers running a business as an S Corporation, specifically situations where a taxpayer-shareholder is either taking distributions from the S Corporation and not paying themselves reasonable compensation, or the taxpayer-shareholder is claiming a loss as reported on the Schedule K-1 (Form 1120-S) when they lack sufficient basis to claim the loss.
To identify these situations, the IRS introduced Form 7203 - S Corporation Shareholder Stock and Debt Basis Limitation. Form 7203 contains a detailed accounting of the shareholder’s basis in the corporation and replaces the requirement that the taxpayer-shareholder attach a basis statement to their return when they reported a loss or receive a distribution.
Beginning in tax year 2022, a taxpayer that receives a Schedule K-1 (Form 1120-S) should attach Form 7203 to their Form 1040 if any of the following are true:
- The taxpayer-shareholder disposes of his/her stock during the tax year.
- The taxpayer-shareholder receives a distribution from the S Corporation.
- The taxpayer-shareholder receives a loan repayment from the S Corporation during the tax year.
- The taxpayer-shareholder claims a deduction for a loss coming from the S Corporation.
The IRS recommends that an S Corporation shareholder complete Form 7203 every year and maintain the form in their tax records even in years where none of the above apply. Maintaining Form 7203 annually allows taxpayer to have the information available when required in a future tax year.
Failing to include Form 7203 on a tax return in future years may result in the IRS disallowing any losses reported on the Schedule K-1 (Form 1120-S) or subject the taxpayer to a request for the form.
Filing Form 7203 with the tax return shows when a taxpayer-shareholder is receiving cash and/or property distributions from their business on the same return where they report all their other income. If they fail to report compensation on their return, the IRS may take this as an indication that the owner of the business is not paying themselves reasonable compensation as required by law.
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