Form 1120-S

Form 1120-S, U.S. Income Tax Return for an S Corporation, is filed by a corporation with a valid Subchapter S election in effect. Like a partnership return it is primarily an allocation vehicle: income, deductions, credits, and separately stated items are computed at the entity level and passed through to shareholders on Schedule K-1, who report them on their own returns whether or not anything was distributed.

Eligibility is a live condition, not a one-time check. The corporation must have only allowable shareholders, no more than 100 of them, and a single class of stock, and it must not be an ineligible corporation. Disproportionate distributions and side agreements that create differing rights to distribution or liquidation proceeds are the usual second-class-of-stock exposures, and they can terminate the election retroactively. A preparer taking on an S corporation should confirm the election exists and that the eligibility conditions still hold, rather than assuming both from the prior year's return.

The schedule set will look familiar. Schedule K aggregates the separately stated items, Schedule K-1 allocates them per shareholder strictly in proportion to stock ownership on a per-day basis, and Schedules K-2 and K-3 carry the international items. Schedule L is the balance sheet, Schedule M-1 reconciles book to tax, and Schedule M-2 is the account that distinguishes this return from a partnership return: the accumulated adjustments account, alongside columns for previously taxed earnings, accumulated earnings and profits, and other adjustments. AAA governs the character of distributions for a corporation with historical C corporation earnings and profits, and it is maintained under rules that differ from shareholder stock basis. The two are frequently, and incorrectly, treated as the same number.

Two entity-level taxes survive the election. The built-in gains tax applies to a former C corporation that disposes of appreciated assets within the recognition period after conversion. The excess net passive income tax applies where the corporation has accumulated earnings and profits from C years and passive investment income exceeding 25% of gross receipts, and sustained over three years it terminates the election outright.

The recurring examination issue is reasonable compensation. A shareholder-employee who takes distributions while running payroll at an implausibly low salary is the fact pattern the IRS has litigated repeatedly and generally won. The related shareholder-side issue is basis: losses are deductible only to the extent of stock and debt basis, and Form 7203 is the schedule that has to support the claim.

A calendar-year S corporation files by March 15 and can extend six months to September 15 on Form 7004. The late-filing penalty runs per shareholder per month, which scales the same unforgiving way the partnership penalty does.

Related terms: S Corporation Election, Form 1120, Partner Outside Basis and Shareholder Basis, Form 7004

Related skill: Tax return review

The S corporation return lives or dies on rollforwards: AAA, earnings and profits, and shareholder basis, each carried year over year in a workbook that nobody re-derives. Adopt's agents rebuild them from the filing history and flag where the columns stopped agreeing. Sign up free.