S Corporation Excess Distribution

[jhvjhv]

The IRS instruction for S Corporation Stock and Debt Basis clearly states that any non-dividend distribution is tax-free provided the distribution does not exceed the shareholder's stock basis. The Instructions say that If the distribution exceeds the shareholder's Stock Basis, the excess is taxed as a capital gain.

When I complete Form 7203, my Distributions exceeded my Stock Basis, and Form 7203 (Line 15) states my Stock Basis is now zero. I do not see where the excess distribution flowed to From D (Capital Gains). My question is how and when is the excess distribution taxed?

Signed,

Confused

[tagteam]

Form 7203 is a new form.

I will page @Rick19744 for input.

[Rick19744 · Accepted solution]

Pass-through entities become complicated quickly:

1. As noted by @tagteam , form 7203 is a new form to provide the IRS with some standardization on basis tracking.
2. Actually, if your distributions exceed basis on line 5, then line 7 becomes zero and this then flows through to line 15.
3. I am not sure how TT software operates here, but it is doubtful that TT takes any excess distributions at this point and reports this on form 8949.
   1. Not sure how TT wants you to enter the amount on line 6.
   2. I'm assuming that line 6 equals the amount on the K-1 and then TT just enters zero if it exceeds line 5.
   3. As noted, doubtful that TT will take any excess and then report on form 8949
4. As to when this is taxed, it is taxed in the year that the distribution exceeds your tax basis.  Generally this is treated as LT capital gain if you held your S corporation shares for more than a year.  Technically you need to track S corporation basis by share lots.
5. So if you are saying nothing is reflected on your Schedule D, then you will need to manually input the excess distribution on form 8949 and it will then flow to Schedule D.
6. Additionally, if you also have any suspended losses as a result of no basis, then you should be completing form 6198 as well.

[Mike9241]

actually form 7203 doesn't really work.  in the desktop version, it clearly states that the taxpayer must enter the excess distribution of form 8949.

it also has another major failing.

on an S-Corp K-1 I enter $50,000 business loss with material participation and $40,000 as distributions, on form7203 I enter $10,000 as my beginning tax basis. 

Here's what happened in Turbotax. the $40K distributions did not flow to form 7203. I had to enter the amount manually on line 6

I now had a distribution in excess of basis of $30K. I had to enter it manually for schedule D. my stock basis is correctly reported as zero on line15. the loss from the k-1 did not flow to form 7203 so I had to enter it manually on line 36 column A. this carried to column e as a carryover amount.

now the bad part.  Turbotax still allowed the $50K loss on schedule e page 2 when it clearly should have been zero. the way I fixed this is by completing form 6198. I entered $10K on line 6 and also on line 9. this corrected schedule e so no loss was allowed. there is nothing on the 7203 or K-1 to warn taxpayers that additional steps may be necessary to have an accurate return.  

taxpayers need to be aware of the failings of form 7203. they could easily materially understate their tax liability by relying on this form to correctly report items.