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I'll be using hypothetical numbers to make this easier to visualize.

I purchased 2000 shares from an S-corporation for $4000 in December of 2014. I received $1000 in distributions for the shares (box 16 code D on the Schedule K-1). This represents 0.10% ownership of the company, which translates to +$2000 in the company income/loss (box 1 on K-1).

I see a lot of mumbo jumbo online regarding calculating your share cost basis to determine taxable amount. For my 2014 taxes, does this mean that I need to pay taxes on the full $2000 of the company income/loss, or does the amount I've received in distributions ($1000) affect the taxable amount?

The tax code seems to indicate that my cost basis affects the taxable amount, but I don't see how this makes sense. It seems to me that cost basis only applies to when I sell the stock. Then again, I don't see how paying more in taxes than distributions received makes sense either.

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Amounts on line 1 of the K-1 are translated into taxable income to you.

Amounts on line 16 of the K-1 with code D are translated into reduction of your cost basis for the shares. If your cost basis is already $0 - they are translated into capital gains.

You need to track and adjust your cost basis in the shares. When you sell your shares - you'll pay capital gains tax on the difference between the proceeds and the adjusted basis. When distributions wipe out your basis, further distributions are treated as gains, and taxed at the year distributed.

So at the end of 2014, your adjusted cost basis in these shares is $3000: $4000 you paid - $1000 you got back (distribution on line 16 with code D).

  • Are you certain it is correct that further distributions exceeding the base are treated as gains AND are taxed as such in the year distributed? – adelphospro Apr 24 '15 at 15:49
  • Yes. Read the linked article. – littleadv Apr 24 '15 at 15:58
  • That's what confused me. The information in the linked article is a bit ambiguous and seems to imply as you stated, however Form 8949 clearly states that it only applies in specific cases related to the disposal or transfer of the investment. It seems that this form is required when filing a schedule D. – adelphospro Apr 24 '15 at 17:31
  • @adelphospro the the instructions you linked, the portion that starts "Use Schedule D". – littleadv Apr 25 '15 at 2:03
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You still own the shares, so cost basis is not relevant because there's no gain or loss on the shares until you sell them. It's much simpler than you fear: fill out a Schedule E with the $2000 from box one of the K1. Answer the questions on the Schedule E and the final amount goes on Line 17 of your 1040. It'll probably be the same $2000 on Line 17 if you don't have any deductions (like a section 179) to apply. [Standard caveat about getting a tax professional to check it over goes here.]

The amount actually distributed to you doesn't have any effect on your tax return. Typically/hopefully, companies will distribute at least enough to offset any income tax you have to pay as a result of the K1 amounts, but they don't have to.

  • No, this is incorrect. – littleadv Apr 24 '15 at 1:18
  • What is incorrect about this answer? – adelphospro Apr 24 '15 at 14:34
  • "The amount actually distributed to you doesn't have any effect on your tax return." – littleadv Apr 25 '15 at 2:01

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