Tax Practice News is offering a webinar later this month on Form 7203 and its impact on passthrough businesses and owners. The form requires partners and shareholders from partnerships and S Corps to essentially provide basis calculations now as part of their individual tax filings.
The point of 7203 is to assess debt basis limitations especially when passthrough entities are claiming losses. What many passthrough owners may not understand as part of this filing requirement is:
- 1. How and when losses may be limited
- 2. How and when distributions may suddenly be taxable
It is no surprise that this reporting is being put into play. Because debt basis was not previously required to be reported, it was easier for passthrough owners, whether intentional or not, to take losses beyond their debt basis or treat distributions as non-taxable when the basis was not there to support it.
Passthrough owners expecting to be able to use losses to offset other income may be surprised if suddenly they are forced to properly limit losses. Yes, they should have been all along but if a preparer missed it, the client may not be aware that those losses will be deferred to future years.
Most notably though, will be the proper taxation of distributions beyond basis. This is another area where preparers may not have previously been keeping a tight look on the debt basis and what was allowed.
Traditionally, distributions from partnerships or S Corporations are treated as tax free distributions from earnings or return of equity. But if those distributions exceed a positive debt basis, they’re subject to the same rules as a dividend from a C Corporation and taxed at a 15% long term capital gains rate.
The 7203 is not new, but lack of clear guidance and education for preparers has made it difficult to ensure that all passthrough returns were in compliance. Additionally, many small passthrough business owners did not have good records of basis. Preparers should plan to spend more time on passthrough business returns this filing season knowing that these records may take some time to put into place.
If you are looking for more guidance on 7203, join us at 12 p.m. (EST), Feb. 16., when we discuss the form as well as tax planning strategies surrounding compensation and distributions for your passthrough entity owners.