How to Follow 1120-S Instructions for Filing S Corporation Taxes

S corporations must file Form 1120-S annually to report income, deductions, and other financial details to the IRS. Unlike traditional corporations, S corps pass profits and losses directly to shareholders, avoiding double taxation. Properly completing this form ensures compliance with tax laws and accurate reporting of business activity.

To handle this process correctly, businesses need to understand how to report earnings, allocate shares among owners, and complete required schedules.

Filing Scope and Requirements

Form 1120-S applies exclusively to businesses that have elected S corporation status with the IRS by filing Form 2553. This election allows the company to be treated as a pass-through entity for tax purposes, meaning the corporation itself does not pay federal income tax. Instead, income, losses, deductions, and credits flow through to shareholders, who report them on their individual tax returns.

To qualify as an S corporation, a business must meet specific criteria: it cannot have more than 100 shareholders, may issue only one class of stock, and all shareholders must be U.S. citizens or resident aliens. If these conditions are not met, the IRS can revoke S corporation status, causing the business to be taxed as a C corporation.

The filing deadline for Form 1120-S is March 15 for calendar-year corporations. Businesses operating on a fiscal year must submit the return by the 15th day of the third month following the end of their tax year. If additional time is needed, a six-month extension can be requested using Form 7004, though this does not extend the deadline for tax payments. Late filings can result in penalties of $220 per month per shareholder, up to 12 months, under IRC Section 6699.

Many states require S corporations to file separate state tax returns, and some impose franchise or entity-level taxes. For example, California levies a 1.5% tax on net income with a minimum payment of $800, while New York has a fixed-dollar minimum tax based on gross receipts. Businesses must verify state-specific obligations to avoid compliance issues.

Reporting Income and Deductions

Form 1120-S requires a detailed account of financial activity, ensuring all revenue sources and deductible expenses are accurately reported. Gross receipts or sales represent total income before adjustments. Businesses must account for returns, allowances, and cost of goods sold (COGS) to determine gross profit. COGS includes direct expenses such as raw materials, labor, and overhead tied to production.

Deductions reduce taxable income passed to shareholders. Common deductible expenses include wages, rent, depreciation, and business loan interest. The IRS allows immediate expensing of qualifying assets under Section 179, up to $1,220,000 in 2024, with a phase-out beginning at $3,050,000 in total asset purchases. Businesses may also use the Modified Accelerated Cost Recovery System (MACRS) to spread deductions over an asset’s useful life.

Operating expenses such as advertising, office supplies, and insurance must be ordinary and necessary for business operations. Meals are generally deductible at 50%, while entertainment expenses are not deductible unless they meet strict business-related criteria. Bad debts can be written off if properly documented as uncollectible, following the direct write-off or allowance method.

Certain deductions require additional scrutiny. Charitable contributions are limited to 25% of taxable income before specific deductions. Employer contributions to retirement plans, including SEP IRAs and 401(k)s, are deductible but must comply with IRS limits. Health insurance premiums for shareholder-employees owning more than 2% of the company must be reported as wages on their W-2 but remain deductible for the corporation.

Allocation for Shareholders

Ownership in an S corporation determines how profits, losses, and other tax attributes are distributed. Unlike partnerships, where allocations can be customized, S corporations must allocate income strictly based on each shareholder’s percentage of stock ownership.

Ownership changes during the tax year require prorated income and deduction allocations based on the number of days each party held an interest unless the corporation elects a special allocation method under IRC Section 1377(a)(2) or Treasury Regulations Section 1.1368-1(g). This election allows income to be divided based on specific closing dates of ownership changes rather than a simple daily proration.

Distributions to shareholders must be tracked to determine taxability. If a shareholder receives distributions exceeding their stock basis—their initial investment plus any retained earnings allocated to them—amounts beyond the basis are taxed as capital gains. Basis adjustments occur annually and are influenced by allocated income, losses, and any additional capital contributions. Losses passed through to shareholders can only be deducted to the extent of their basis. If a shareholder’s basis reaches zero, excess losses are suspended until additional basis is restored through future earnings or contributions.

Completing Schedule K-1

Schedule K-1 reports each shareholder’s portion of the corporation’s financial activity, aligning with their ownership percentage. The form includes ordinary business income, rental real estate activity, interest and dividend income, capital gains, and other separately stated items that require special tax treatment.

Certain income types reported on Schedule K-1 are subject to different tax rates. Qualified dividends are taxed at preferential capital gains rates, while ordinary business income may be subject to self-employment tax considerations under certain circumstances. The form also details tax-exempt income, which affects a shareholder’s stock basis but does not contribute to taxable income. Additionally, credits such as the general business credit or foreign tax credit flow through to shareholders and may be subject to individual limitations.

Attaching Additional Schedules

Form 1120-S requires supporting schedules to provide a detailed breakdown of financial activities. These schedules help the IRS assess compliance with tax laws and ensure accurate reporting.

Schedule B

Schedule B gathers information about the corporation’s structure, ownership, and financial transactions. It asks whether the corporation has foreign shareholders, owns interests in other entities, or engaged in transactions requiring special reporting, such as those involving related parties under IRC Section 267. It also requires disclosure of stock ownership changes and whether the corporation made payments requiring Form 1099 reporting.

Businesses with international operations must report foreign bank accounts and transactions with controlled foreign corporations (CFCs) under IRC Section 6038, which can have significant compliance implications.

Schedule K

Schedule K consolidates the corporation’s income, deductions, credits, and other tax attributes before they are allocated to shareholders via Schedule K-1. It includes net rental real estate income, tax-exempt interest, and Section 179 depreciation deductions. The schedule also captures pass-through tax credits, including the research and development credit under IRC Section 41 and the work opportunity tax credit under IRC Section 51.

If the corporation has passive income exceeding 25% of gross receipts and retained earnings from prior C corporation years, it may be subject to the excess net passive income tax under IRC Section 1375.

Schedules M-1 and M-2

Schedules M-1 and M-2 reconcile book income with taxable income and track changes in retained earnings. Schedule M-1 explains discrepancies between financial statements and tax returns, such as non-deductible expenses like penalties and fines or income items not included in taxable income, such as life insurance proceeds.

Schedule M-2 tracks the corporation’s accumulated adjustments account (AAA), which reflects post-S election earnings available for tax-free distributions. If the AAA balance is negative, it may indicate excessive distributions or losses exceeding income, which could affect shareholder basis calculations.

Extensions and Payment Options

S corporations needing additional time to file Form 1120-S can request an automatic six-month extension by submitting Form 7004 by the original due date. While this extends the filing deadline, it does not defer tax payments, meaning any estimated taxes owed must still be paid by the original deadline to avoid penalties and interest.

Estimated tax payments are generally not required for S corporations at the federal level since income flows through to shareholders. However, some states impose estimated tax requirements, particularly those with entity-level taxes. For example, California requires estimated payments if annual tax liability exceeds $500.

Amended Return Procedures

If an S corporation discovers errors after filing Form 1120-S, it must file an amended return using Form 1120-S with the “Amended Return” box checked. Corrections to shareholder allocations also require issuing amended Schedule K-1s.

Amended returns may be necessary to correct misreported income, deductions, or credits, or to claim missed tax benefits. If the amendment results in additional tax liability for shareholders, they may need to file amended individual returns using Form 1040-X.

Recordkeeping

S corporations should retain tax returns, financial statements, and supporting documents for at least three years. Records related to shareholder basis, depreciation schedules, and capital contributions should be kept indefinitely.

Proper documentation is essential for tracking stock basis, as errors can lead to incorrect tax treatment of distributions and loss deductions. The IRS may request documentation during audits, and failure to provide adequate records can result in disallowed deductions or penalties.