Post 1986 Depreciation Adjustment on Form 1120S: What S Corporations Need to Know
Understand how S corporations handle post-1986 depreciation adjustments on Form 1120S with practical guidance for accurate tax reporting.
S corporations filing Form 1120S often encounter various tax adjustments, with the post-1986 depreciation adjustment being a frequent point of inquiry. This line item can affect a shareholder’s basis and overall tax liability, making its accurate calculation important.
Understanding this adjustment is part of navigating S corporation taxation for proper reporting and compliance. Missteps can lead to IRS scrutiny or unintended tax outcomes for shareholders.
When the Adjustment Is Required
The need to calculate the post-1986 depreciation adjustment arises from the Alternative Minimum Tax (AMT) rules. While S corporations typically do not pay corporate AMT, they must compute AMT adjustments and preference items. These items flow through to the shareholders via Schedule K-1 (Form 1120S).
Shareholders use the information from Schedule K-1 to determine their individual AMT liability, often calculated on Form 6251, Alternative Minimum Tax—Individuals.
This specific adjustment is necessary when the depreciation deduction claimed for regular income tax differs from the amount allowed under AMT rules for tangible property placed in service after December 31, 1986. Internal Revenue Code Section 56 generally requires different depreciation calculations for AMT purposes compared to regular tax for such property.
Therefore, if an S corporation uses a depreciation method or recovery period for regular tax that differs from what is required for AMT for any eligible post-1986 asset, an adjustment must be calculated. The S corporation reports each shareholder’s share of this difference on Schedule K-1.
Which Assets Are Subject to This Adjustment
The post-1986 depreciation adjustment applies primarily to tangible properties acquired and placed in service after December 31, 1986. Intangible assets are subject to different AMT adjustment rules and are not included in this specific calculation.
Assets generating this adjustment are typically those depreciated using the Modified Accelerated Cost Recovery System (MACRS) for regular tax purposes, as outlined in Internal Revenue Code Section 168. The adjustment arises when the MACRS method (often accelerated) differs from the method required for AMT, which is generally the Alternative Depreciation System (ADS).
Certain assets do not typically generate this AMT depreciation adjustment. Property placed in service before 1987 is excluded. Assets depreciated using methods not based on a term of years, like the units-of-production method, are also excluded, according to IRS Publication 946, How To Depreciate Property.
If the S corporation elects to use the ADS method for an asset for regular tax purposes, no adjustment is needed for that specific asset because the regular tax and AMT depreciation amounts will be the same. Additionally, the Section 179 expense deduction claimed by the S corporation does not, by itself, create this specific AMT depreciation adjustment.
Calculating the Adjustment
Calculating the adjustment involves comparing the depreciation deduction taken for regular income tax with the depreciation allowed under AMT rules for each eligible asset. The calculation is: Regular Tax Depreciation minus AMT Depreciation for the asset for the tax year.
Regular tax depreciation for tangible property placed in service after 1986 is usually determined using MACRS. This system often permits accelerated methods (like 200% or 150% declining balance) over specific recovery periods, leading to larger deductions in the early years of an asset’s life.
AMT depreciation for the same property generally must be calculated using ADS, as specified in Section 168. ADS typically requires the straight-line method over longer recovery periods than MACRS. However, for certain tangible personal property, Section 56 specifies using the 150% declining balance method over the ADS recovery period for AMT, switching to straight-line when it yields a larger deduction.
Even for property placed in service after December 31, 1998, where MACRS and ADS recovery periods might align, the depreciation method (e.g., 200% declining balance for regular tax vs. 150% declining balance or straight-line for AMT) often still differs, requiring an adjustment.
If regular tax depreciation exceeds AMT depreciation (common in early years), the result is a positive adjustment. If AMT depreciation is greater (possible in later years), the result is a negative adjustment.
This calculation is performed for every eligible asset, and the individual adjustments are netted together to find the total adjustment for the S corporation. This net amount reflects the overall difference between the two depreciation systems for the year. The basis of the property must be tracked separately for regular tax and AMT purposes, reduced by the depreciation allowed or allowable under each system.
Reporting It on Form 1120S
After calculating the total post-1986 depreciation adjustment, the S corporation reports this information on its Form 1120-S, U.S. Income Tax Return for an S Corporation. This ensures the adjustment is properly accounted for at the shareholder level.
The total net adjustment amount is reported on Schedule K of Form 1120-S, which summarizes shareholders’ total share of various corporate items, including those relevant for AMT.1Internal Revenue Service. Instructions for Form 1120-S
Following Subchapter S principles, specifically Section 1366 regarding pass-through items, the total adjustment from Schedule K is allocated among shareholders based on their pro rata share of stock ownership.
Each shareholder receives a Schedule K-1 (Form 1120-S), detailing their portion of the S corporation’s items. The post-1986 depreciation adjustment is reported in Box 15, designated for AMT items, using Code A.2Internal Revenue Service. Shareholder’s Instructions for Schedule K-1 (Form 1120-S) This provides shareholders the figure needed for their individual AMT calculations.
Maintaining detailed depreciation schedules is necessary to support these figures. These schedules track both regular tax (MACRS) and AMT (ADS or 150% declining balance) depreciation. Calculations are often summarized on Form 4562, Depreciation and Amortization, filed with Form 1120-S.
Common Errors to Avoid
Several common errors can occur when calculating the post-1986 depreciation adjustment. One involves incorrectly applying the ADS rules for AMT, such as using the wrong recovery period or failing to use the straight-line method when required.
Another frequent error relates to tangible personal property. For certain post-1986 tangible personal property, AMT depreciation requires the 150% declining balance method, not straight-line ADS. Using the wrong method leads to an incorrect adjustment.
Failing to maintain separate basis tracking for both regular tax and AMT is a significant issue. The adjusted basis for AMT must reflect prior AMT depreciation deductions. Incorrect AMT basis distorts current year calculations and the gain or loss computed for AMT purposes upon asset disposition, which itself can create a separate AMT adjustment.
Confusion also arises over which assets are subject to the adjustment. Applying these rules to assets placed in service before 1987 is incorrect. Similarly, including adjustments for assets where ADS was elected for regular tax purposes is an error, as no difference exists between regular and AMT depreciation in that case. The Section 179 deduction should also not be confused with this specific depreciation adjustment.
Overlooking the potential for negative adjustments in later years is another pitfall. While regular tax depreciation is often higher initially (positive adjustment), AMT depreciation can exceed regular tax depreciation later (negative adjustment). Failing to account for negative adjustments overstates the cumulative difference between the systems and impacts AMT basis tracking.