(For the tax preparation of single member limited liability companies, partnerships, and C corporations click here, here, and here respectively.)
S corporations seem to have become many taxpayers chosen business entity without understanding almost any of the basic tenets of their taxation. This is nothing against those that form them, and more about the fact there seems to be many business professionals that advocate for their formation without apprising their clients of just what they are signing up for. This is a basic overview of how S corporations are taxed, and in no way represents what a person would need to completely prepare an S corporation return. That being said, it’s good to have an overview because it could help guide you in the right direction on basic questions that the public appears to be generally unaware of.
The first thing that must be emphasized is that there are two common ways to form an S corporation, the first is to form a C corporation and then make the S corporation election, while the other way is to form a limited liability company and then elect to become an S corporation. This election is made using federal Form 2553. Note that when this article mentions S corporations, it means a company that elected to be an S corporation through one of these two methods.
Next, if you work for your S corporation, meaning if you perform work in any principal capacity for the company, you MUST pay yourself a wage or a salary for that work, and therefore go through formal payroll withholding, and send yourself a W-2 at the beginning of the following year. Again, this is non-negotiable. So, for example, if you are a shareholder/owner of an S corporation, and your company mows lawns, and you do the actual work mowing the lawns, you have to pay yourself a wage or salary and send yourself a W-2. Another example, same lawn care company, if you had a role as a manager, you would also have to pay yourself a wage or salary and send yourself a W-2. The point is that this is an immutable requirement that does not change based on the position you hold in your company. If you are a shareholder of an S corporation who also works for the business in any capacity, then you are bound by a formal wage/salary structure, payroll, quarterly federal filings, and a Form W-2.
Now, on to discussing the substantive portion of preparing your S corporation return, which is centrally prepared through Form 1120S, the primary form, analogous to Form 1040 for individuals. This is the form through which all other forms and schedules making up your S corporation return flow into. You’ll see that at the top of the form you provide fundamental information about your company, such as company name, the date your company elected to be an S corporation, employer identification number, the date incorporated, and the total assets of the company.
After this, there are two sections from which the tax accounting for the corporation is computed – the income and deductions sections. Within the income section, there are all components of income plus accounting for cost of goods sold, for which you’ll use Form 1125-A. Note that cost of goods sold pertains to businesses that deal in inventories of goods.
After you’ve gotten through the income section, which culminates on line 6 with total income (or loss), you move on to the deductions section, which as the name suggests, is about deducting business expenses from income. A couple things to note here, first, unlike Forms 1065 and 1040, line 7 of 1120S is where you list the cumulative compensation of officers. This is what I referenced earlier, in that you put the total income paid out by the S corporation for shareholders that also work for the company. If you leave this line blank, the IRS will wonder how you compensated those shareholders who also work for the company.
The final section on the first page, the tax and payments section, should generally just be ignored because S corporations don’t pay taxes, and the taxes referenced in this section are outside the scope of this article. So for our purposes, don’t worry about this section, but if you feel as though you need to be concerned, then please seek the help of a professional.
On pages two and three, Schedule B, other information, you’ll encounter mainly a series of yes/no questions pertaining to the structure, ownership, and finances of the company. Note that you’ll have to articulate the method of accounting along with the business activity and product or services your S corporation provides.
Next, on page 3 you’ll find Schedule K, which is the shareholders’ cumulative share of items such as income, deductions, credits, and other information. This section is basically where you show the amount of income and deductions that are going to shareholders collectively. So, for example if the total income from the S corporation was $200,000, the Schedule K would reflect the fact that this combined $200,000 was distributed to all the shareholders of the S corporation.
The last portion of the Form 1120S that’s worth mentioning for this introduction to S corporation returns is the Schedule L, which is the balance sheet, found on page 4. Balance sheets are fairly complicated because they require knowledge of assets and liabilities and a detailed description of the categories making up the aforementioned as they fit in the context of a particular company. So, suffice it to say here that the assets and liabilities should be equal to one another, or in the lingo, they should balance. Therefore if Company A has $60,000 in assets, it should also have $60,000 in liabilities.
Lastly, like partnerships, S corporations issue each shareholder a Schedule K-1, which is the per shareholder allotment of income and deductions, amongst other items. Simply put, it can be thought of as a statement of the portion of the profits that were distributed to a given shareholder. In the same way that a Form W-2 is the information return associated with employment, the Schedule K-1 can be thought of as the profit information return for shareholders of S corporations.
Again, this article went into the basics of preparing an S corporation return. It’s therefore advisable to seek the help of a professional tax preparer if this is your first rodeo because it only gets more complicated from here.
If you need help with your S corporation’s return, or you have any other tax issues or problems, don’t hesitate to contact Dino Tax Co today at (713) 397-4678 or email firstname.lastname@example.org. Your initial consultation with us is always free. Also, consider liking us on Facebook: www.facebook.com/dinotaxco.
Leave A Comment