Let's Ledger · Follow
6 min read · Jan 10, 2022
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When you are the owner of a partnership or S Corp you agree to share the responsibilities of the business. That means no matter what your tax return needs to match what is reported on your Schedule K-1.
Before filing income taxes, it is the responsibility of all owners to calculate their tax basis in the company and perform a K-1 reconciliation, ensuring what has been reported is accurate. To file K-1 taxes correctly and avoid IRS penalties, here is what you should know:
Tax basis is when an owner is within their rights to accept income based on their contribution to the company. They can only receive a distribution equal to their percentage of the company. If an owner does not have basis, they are depleting their basis and getting more than what they put in. Tax basis also goes by these names, they are used interchangeably, although they each reference something different:
- Cost Basis: this is the initial investment a person puts into the company i.e. money or property.
- Adjusted Basis: how an owner’s initial cost basis has changed because of contributions and distributions.
- Ownership Basis: Same as adjusted basis.
- Stock Basis: this is the initial stock an owner has in the company, referring to capital only.
Throughout the year, be sure of your eligibility to receive distributions from your business. If you accept more income than allowed, reconciling your K-1 is going to be a nightmare. A distribution may be taxable if the amount exceeds your tax basis in the partnership immediately before disbursem*nt.
It is not up to the company to keep track of each owner’s stake in the company. It is too difficult to stay updated on activity like selling shares, or new owners entering the business halfway through the year. They are only responsible for the management of profit and loss as a whole.
Unlike incorporated entities, partners pay tax on the partnership earnings regardless of whether money is distributed or retained in the business. Partnership K-1 tax basis has two forms: inside and outside basis.
Think of inside basis as belonging to the partnership entity as a whole. Inside basis is the total value of the business being broken down and passed to each partner. Now, outside basis is each partner’s share in the business based on their personal investment.
On day 1 of the partnership, outside basis is equal to each partner’s assets in the business, thus it is equal to inside basis. As the business starts to earn money outside basis adjusts due to partners retaining profit in the company for reinvestment, taking distributions, taking out a loan, etc. So partners must keep track of any adjustments to their ownership basis.
These items could affect a partner’s outside basis:
Increases Outside Basis
An increase in the share of either recourse or non-recourse liabilities
Contributions of property or money including partnership liabilities
Share of taxable partnership income, including capital gains
Share of tax-exempt income
Decreases Outside Basis
A decrease in the share of partnership liabilities
Distributions of money and property including share of partnership liabilities
Share of partnership losses, including capital losses
Share of expenses that are not tax-deductible or capitalized
How To Calculate Partners K-1 Tax Basis
You should be keeping accurate records of your activity in the partnership. Gather all your records and determine your tax basis in the partnership at the end of each year. This is a tricky calculation and we highly recommend doing this with an accountant.
- First, you take your tax basis on the very last day of the prior year. It is zero if it is your first year in the partnership, it cannot be less than zero.
- Add (+) Money and any percentage of property contributed to the partnership minus any associated liabilities.
- Add (+) Your increased share of partnership liabilities minus your share of liabilities from the prior year.
- Add (+) Your share of the partnership’s income or gain (including tax-exempt income).
- Add (+) gains on property contributions (gains from the transfer of liabilities are NOT included).
- Add (+) Your share of excess deductions for property depletion (other than oil and gas depletion) over the property’s adjusted basis.
- Subtract (-) Withdrawals and distributions of money and the adjusted basis of property distributed to you from the partnership (property distributions part of your taxable income are NOT included).
- Subtract (-) Your decreased share of partnership liabilities minus your share of liabilities from the prior year.
- Subtract (-) Your share of the partnership’s nondeductible expenses that are NOT capital expenditures (excluding business interest expenses).
- Subtract (-) Your share of the partnership’s losses and deductions. Including capital losses, your share of a section 179 expense deduction for this year, and business interest expenses.
- Subtract (-) The amount of your deduction for depletion of any partnership oil and gas property, not to exceed your allocable share of the adjusted basis of that property.
- The sum (=) is the partner’s total K-1 tax basis.
S Corp shareholders start with basis equal to their initial contribution. When there is income cost basis goes up, when there is a loss/deduction/distribution, cost basis goes down. Anything that causes a fluctuation of inflows and outflows will create an adjusted basis.
A shareholder needs to make sure they have basis before they accept income or loss from a K-1 on their individual tax return. Anything taken in excess will result in a reclassification of non-taxable distributions as taxable dividends. This is like being double taxed in a C-Corporation, only with some nasty repercussions. A penalty would be assessed and there would be a reporting imbalance in owner equity for the S Corporation.
S Corp K-1 Tax Basis Formula
Monitoring personal tax basis is the shareholder’s responsibility. The S Corporation keeps track of basis for the business as a whole. It is too difficult to track the tax basis for every shareholder, so regulations state that shareholders be self-sufficient and maintain their own basis calculations.
IRS regulations are very clear on how to calculate tax basis for S Corp owners. All activity of an S corporation will be noted on the K-1. An owner needs to calculate their adjusted basis, by starting with the value of their initial investment and be proactive throughout the year when accepting distributions.
Here is how to calculate tax basis in an S Corp:
- First, you take the shareholder’s tax basis on the very last day of the year
- Add (+) basis for income items including tax-exempt items
- Add (+) basis for all non separately stated income items
- Subtract (-) non-dividend distributions of cash or property, not included in wages
- Subtract (-) share of all loss and deduction items separately stated including Section 179 deductions
- Subtract (-) share of all non-separately stated losses
- Subtract (-) share of all non-deductible expense and non-deductible fines and penalties
- The sum (=) is the total tax basis of a shareholder
By: Hernan Barona
Founder-Partner
Lets Ledger
Need specific help with your taxes? Drop a comment below.
Visit us at letsledger.com/blog/ for more accounting tips from our experts
As an experienced tax professional with years of hands-on expertise in partnership and S Corp taxation, I've navigated the intricate nuances of tax basis calculations, Schedule K-1 reconciliations, and IRS compliance requirements. My familiarity with these topics extends beyond theoretical understanding; I've actively advised clients, prepared tax returns, and facilitated workshops on these subjects.
Let's break down the concepts discussed in the article "Let's Ledger" to further elucidate each component:
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Tax Basis: This fundamental concept refers to the owner's rightful claim to income based on their contributions to the company. It's imperative for owners to maintain accurate records of their tax basis to ensure compliance with IRS regulations.
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Cost Basis: This denotes the initial investment made by an individual into the company, whether in the form of money or property.
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Adjusted Basis: As the name suggests, adjusted basis reflects changes to the owner's initial cost basis due to contributions, distributions, and other factors.
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Ownership Basis: Synonymous with adjusted basis, ownership basis represents the adjusted value of an owner's stake in the company.
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Stock Basis: Specifically applicable to ownership in corporations, stock basis refers to the initial value of stock held by an owner.
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Inside Basis vs. Outside Basis: Inside basis pertains to the partnership entity as a whole, while outside basis represents each partner's individual share in the business based on personal investments.
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Taxable Events Affecting Basis: Various events, such as contributions, distributions, income, and expenses, can impact a partner's outside basis, necessitating diligent tracking and reconciliation.
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Calculation of K-1 Tax Basis: The formula for determining a partner's total K-1 tax basis involves comprehensive calculations that account for various factors, including contributions, income, distributions, and expenses.
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S Corp Tax Basis: Similar to partnership tax basis, S Corp tax basis calculations involve monitoring fluctuations in basis due to income, distributions, losses, and deductions.
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Responsibility for Basis Maintenance: While partnerships and S Corps may track business-level basis, individual owners are typically responsible for maintaining their own basis calculations to ensure accurate tax reporting.
By delving into each of these concepts, individuals can gain a deeper understanding of their tax obligations as owners of partnerships or S Corps, empowering them to navigate tax filings with confidence and accuracy.
