It’s tax season crunch time. In this episode, Brian will walk you through the S-Corporation income tax return to help you better understand what you’re filing and hopefully catch mistakes before it’s too late. He provides a section-by-section analysis of Form 1120-S and highlights key areas that business owners and tax professionals make mistakes.
Episode Highlights
Part 1: Heading, Income, Deductions, Tax and Payments
Most of this information is drawn from your business’s Profit and Loss Statement. Here’s a breakdown of what’s on the first page:
Calendar year: The very top of the form asks for the calendar year. If the corporation has a calendar year-end, leave this blank. If a fiscal year or short year put in the appropriate dates.
Address: Underneath the calendar year, the form asks for a name and address. Use the name set forth in the charter or other legal documents, such as your Employer Identification Number (EIN) letter.
Item A: Located to the left of the address, Item A asks for your S election effective date. You should have a letter from the IRS (CP 261) with your S-Corp starting date. This date should stay the same every year.
Item B: Your business activity code. This code shows the IRS exactly what you do.
Item C: Item C only applies if you have assets of $10 million or more. Most of the time, Item C will not be checked.
Item D: Put your EIN in Item D. Make sure to verify it’s correct before you file your form.
Item E: Your date of incorporation should match the articles of incorporation. This date may or may not be the same date as your S-election. Like the S-election date, the date of incorporation won’t change.
Item F: Total assets at the end of the year.
Item G: If the corporation is electing to be an S-Corp beginning with the current filing tax year, check the appropriate box. If the S-Corp did not already file the S-Election, attach Form 2553 with the return.
Item H: These boxes should be self-explanatory. Check the boxes that apply.
Item I: Enter the number of shareholders in the firm (e.g. yourself and your partners).
Item J: Most of the time, Item J will not be checked. If you believe that one of the Item J items applies, follow up with your tax accountant.
Income: Report gross revenue your business has earned for the year and any additional income or interest income that you may have incurred. Only report trade or business income. Do not list rental income, portfolio income, or tax exempt income (those go on your Schedule K).
Expenses: Report all deductions on your Profit and Loss statement. Pay special attention to the following lines:
Line 7: Compensation of officers should have something on it. S-Corporations must pay shareholder/employee reasonable compensation for services rendered, and failing to put reasonable compensation could lead to an IRS audit. Also included on this line are fringe benefits, including employer contributions to health plans and group term life insurance, for shareholders/employees owning more than 2% of the corporation stock. If your S-Corp has total receipts of $500,000 or more, you’ll need to attach Form 1125-E to explain what was paid to each officer.
Line 8: Salary and wages paid to employees (other than officers) of the corporation.
Line 17: An S-Corporation can deduct contributions made for its employees under a qualified pension, profit sharing, annuity, SEP plan, Simple plan, or any other retirement deferred compensation plan. This includes shareholders/employees owning more than 2% of the corporation stock.
Line 18: Employee fringe benefits provided to officers and employees owning less than 2% go on this line, such as health insurance, disability insurance, and educational assistance.
Line 19: Line 19 includes any other deductions. There should be an attached statement, and it should match your profit and loss. The numbers should be close to your Profit and Loss statement.
Taxes and payments: In general, an S-Corporation does not pay taxes at the corporate level, so this section will be blank.
Signature: It’s important to sign the return only after verifying all of the information, including the following sections.
Part 2: Schedule B
This section is mostly self-explanatory questions. Make sure to read and understand each question. Below are two lines to pay special attention to:
Box 1: This easy-to-miss box can change your entire return if you’re not careful, since it’s where you select whether you’re a cash or accrual basis taxpayer. Once you choose an accounting method, you generally cannot change without approval from the IRS.
Box 2: Here is where you explain what you do. Part B is an either/or question, so state whether you sell products or services. Also, if you hire contractors, say yes to question 14 -- and hopefully you got out your 1099 forms by January 31.
Part 3: Schedules K and K-1
Schedule K reports the pro rata share items in total for the Corporation. Schedule K-1, which you receive in your personal name, reports the percentage of pro rata share items allocable to each shareholder.
Lines 1-17 on Schedule K correspond to Boxes 1-17 on Schedule K-1. Most items on Schedules K and K-1 are self-explanatory and come from other parts of the return.
Part 4: Schedule L
This is where many taxpayers make a mistake. Schedule L matches your business’ balance sheet and should agree with your books and records. If it doesn’t, find out why before you file.
The first two columns match what your accounts were at the beginning of the year and should match what the accounts were at the end of last year. If this is your first year filing an 1120-S return, these two columns should be blank. The second two columns are for what the accounts had on December 31 of the previous year and will carry over to next year’s return.
Some of the most common assets on Schedule L are:
Line 1: Write the amount of cash in your bank account on the last day of the year.
Line 7: Loans to shareholders are loans from the corporation to the shareholder. Keep in mind, these loans need to be documented and should have a repayment schedule and interest rate.
Line 10a: Buildings and other depreciable assets are fixed assets that the business owns that have been depreciated, such as real estate, furniture, or machinery
Some of the most common liabilities on Schedule L are:
Line 18: Other current liabilities are expenses incurred at the end of the year but not paid until January of the next year. Current expenses often include wages, state taxes, federal taxes, and payroll taxes payable at the end of the year.
Line 19: Loans from shareholders are loans from the shareholder to the corporation. As with the other loans, these loans should be documented and include a repayment schedule and interest rate.
Line 22: The par value or stated value of the capital stock issued by the corporation. This amount stays the same each year unless the S-Corporation issues additional stock after incorporation. The corporate charter or minutes should identify the stock.
Line 23: Enter the beginning and ending balances of additional paid-in capital. This includes the amount contributed to the S-Corp by shareholders for which the corporation did not issue stock or amounts contributed in excess of the stated or par value.
Line 24: This section is especially tricky. You should base the retained earnings on the S-Corporation’s books and records. Most of the time, retained earnings should match the Accumulated Adjustments Account (AAA), other adjustments account (OAA), and previously taxed income (PTI) balances on Schedule M-2.
Line 27: This line represents the total liability and shareholders equity. This line must match line 15.
If you answered “yes” to question 11 on Schedule B that your total receipts were less than $250,000 and total assets were less than $250,000, then you aren’t required to file a Schedule L. However, it may be beneficial to file Schedule L anyway because it will be crucial for future balance sheets.
Part 5: Schedules M-1 and M-2
Schedule M-1 helps explain discrepancies between the books and your tax return. This section should explain any differences you notice.
Some common items reported on Schedule M-2 include:
Meal expenses (100% on books, 50% on taxes)
Entertainment (100% on books, 0% on taxes)
Life insurance premium expense (100% on books, 0% on taxes)
Certain fines and penalties (100% on books, 0% on taxes)
Political contributions (100% on books, 0% on taxes)
Book depreciation expense (100% on books, 0% on taxes)
Tax depreciation expense (%0 on books, 100% on taxes)
Tax-exempt income (100% on books, %0 on taxes)
Schedule M-2 tracks the income and losses and separately states items that the shareholder should report on their tax return.
Resources + Links
About Brian and the Mission Driven Business Podcast
Brian Thompson, JD/CFP, is a tax attorney and certified financial planner who specializes in providing comprehensive financial planning to LGBTQ+ entrepreneurs who run mission-driven businesses. The Mission Driven Business podcast was born out of his passion for helping social entrepreneurs create businesses with purpose and profit.
On the podcast, Brian talks with diverse entrepreneurs and the people who support them. Listeners hear stories of experiences, strength, and hope and get practical advice to help them build businesses that might just change the world, too.
