ESOP S Corporation Basis Adjustments
My previous blog post discussed the Importance of Tracking Cost Basis in ESOPs. Today I want to expand on this topic and discuss how S Corporation Basis Adjustments apply to ESOPs and impact cost basis as well.
IRS Revenue Ruling 2003-27 provided guidance that an ESOP is required to adjust its basis in S corporation stock under IRC Section 1367(a) for the ESOP's pro rata share of the corporation's items. It also provided that upon the distribution of S corporation stock by an ESOP to a participant, the stock's net unrealized appreciation under IRC Section 402(e)(4) is determined using the ESOP's adjusted basis in the stock.
To determine the cost basis adjustment, the S corporation should issue the ESOP trustee a Schedule K-1. Detailed instructions for determining the cost basis adjustment using the values reported on the Schedule K-1 can be found on the IRS Website. In summary, the following values are used to determine the cost basis adjustment:
A shareholder's stock basis is increased by (using Schedule K-1 line items):
| |
Schedule K-1 |
| 1. Ordinary income |
Line 1 |
| 2. Separately stated income items |
Lines 2 - 10 |
| 3. Tax exempt income |
Lines 16a & 16b |
| 4. Excess depletion |
Line 15c |
A shareholder's stock basis is decreased, but not below zero, by:
| |
Schedule K-1 |
| 1. Ordinary loss |
Line 1 |
| 2. Separately stated loss items |
Lines 2 - 12d
and 14l, 14m |
| 3. Nondeductible expenses |
Line 16c |
| 4. Non-dividend distributions |
Line 16d |
| 5. Depletion for oil and gas |
Line 17r |
Summary
Tracking the cost basis of shares in an ESOP allows participants the opportunity to elect NUA tax benefits. To further complicate NUA determination, stock of an S corporation held by an ESOP is subject to the same basis adjustments required by any other S corporation shareholder. Detailed recordkeeping of the stock transactions and related cost basis on an annual basis is a best practice and will alleviate frustration and inaccuracy in the future.