Form K-1 (1120-S): What Shareholders Need to Know

An S Corporation shareholder receives a Schedule K-1 (Form 1120-S) to report their share of the company’s financial results. This document is a consequence of the S Corporation’s pass-through tax structure, where the business itself does not pay federal income tax. Instead, profits, losses, deductions, and credits are passed through to the owners, who must report these items on their personal tax returns. The corporation sends a copy of each K-1 to the IRS with its informational return, Form 1120-S, allowing the IRS to verify that shareholders have correctly reported their share of the business’s activity.

Information Required for Form K-1 Preparation

An S Corporation must gather specific details to accurately complete a Schedule K-1 for each shareholder. This process begins with collecting shareholder information, including their legal name, current address, and Social Security Number or Taxpayer Identification Number. This data populates Part II of the form. The corporation must also maintain precise records of each shareholder’s stock ownership percentage throughout the year, noting any changes in ownership.

After the corporation completes its main tax return, Form 1120-S, it allocates the total amounts of income, deductions, and credits among the owners based on their ownership stake. For instance, a shareholder who owns 25% of the corporation for the entire year would be allocated 25% of the company’s ordinary business income, interest income, and charitable contributions.

Understanding the Shareholder’s Form K-1

Schedule K-1 is a structured report of your share of the S Corporation’s financial year, divided into three main parts. Part I provides identifying information about the corporation, such as its Employer Identification Number (EIN) and address. Part II contains your personal information, including your name, address, and your percentage of stock ownership for the tax year.

Part III is the most detailed section, outlining your specific share of the corporation’s income, deductions, and credits. For example, Box 1 shows your share of ordinary business income or loss from the corporation’s primary operations. Box 2 reports net income or loss from rental real estate activities, while Box 5 details your portion of any interest income the corporation earned.

Box 12 often contains a figure for the Section 179 deduction, which allows businesses to expense the cost of certain property. Box 13 will have various codes for different tax credits, such as credits for low-income housing or renewable energy. Box 17 provides “Other Information” for items that do not have a dedicated line. One of the most common is related to the Qualified Business Income (QBI) deduction under Section 199A, and you will likely see codes representing your share of the corporation’s QBI, associated W-2 wages, and the unadjusted basis of qualified property.

Reporting K-1 Information on Your Personal Return

The next step is to transfer the figures from your Schedule K-1 to your personal tax return, Form 1040, or its associated schedules. This process is a direct mapping of the boxes on the K-1 to specific lines on your personal tax forms. The amount from Box 1, representing ordinary business income or loss, is reported on Schedule E (Form 1040), Part II.

Interest income from Box 5 is carried to Schedule B (Form 1040), which is used for reporting interest and ordinary dividends. Similarly, ordinary dividends found in Box 6 of the K-1 are also reported on Schedule B. Any royalties from Box 7 would be reported on Schedule E.

Information related to the Qualified Business Income (QBI) deduction, found in Box 17, is used to complete Form 8995, Qualified Business Income Deduction Simplified Computation, or Form 8995-A for more complex situations. The final calculated QBI deduction from Form 8995 or 8995-A is then entered on the designated line of your Form 1040.

Shareholder Basis and its Tax Implications

A shareholder in an S Corporation must track their stock basis, which is a measure of their economic investment in the company. Basis is a separate calculation from the income and loss reported on the K-1, but it is directly affected by those items. Initially, your basis is the amount you paid for the stock plus any capital you contributed to the corporation, and this figure must be adjusted annually.

Each year, your basis increases by your share of the corporation’s income and gains. Conversely, your basis decreases by your share of the corporation’s losses and deductions, as well as any distributions you receive from the corporation. These distributions are often reported in Box 16 of the K-1 with code “D” for property distributions. It is the shareholder’s responsibility to maintain these records, often using Form 7203, S Corporation Shareholder Stock and Debt Basis Limitations.

The amount of corporate losses you can deduct on your personal return is limited to your basis in the corporation’s stock and any loans you have made to it. If your share of losses exceeds your basis, the excess loss is suspended and carried forward to future years. Basis also determines the tax treatment of distributions; a distribution is a tax-free return of your investment up to the amount of your basis, and any distribution in excess is treated as a taxable capital gain.