S Corp K-1: How to Report Income and Distributions

An S Corporation shareholder receives a Schedule K-1, a tax document that outlines their portion of the company’s financial results for the year. This form, officially titled “Shareholder’s Share of Income, Deductions, Credits, etc.,” is an informational report providing the figures a shareholder needs to complete their personal income tax return, Form 1040. The K-1 is issued by the S corporation after it files its own annual tax return, Form 1120-S.

Key S Corporation Tax Concepts for Shareholders

S corporations operate under a “pass-through” taxation model. This means the corporation itself does not pay federal income tax on its profits; instead, the income, losses, deductions, and credits are passed directly to the shareholders. Each shareholder then reports these items on their personal tax return and pays tax at their individual income tax rates. This structure avoids the “double taxation” that C corporations face.

A point of confusion for shareholders is the distinction between the income reported on their K-1 and the actual cash distributions they receive. The income shown on the K-1 represents the shareholder’s portion of the company’s profit for the year, and this amount is taxable to the shareholder regardless of whether any cash was paid out. For example, if an S corporation with two equal shareholders earns a $100,000 profit, each shareholder will receive a K-1 showing $50,000 of income to report on their tax return.

Distributions are actual payments of cash or property from the corporation to a shareholder. These payments are often tax-free, provided they do not exceed the shareholder’s stock basis. If the same corporation distributes only $20,000 to each shareholder, they still report and pay tax on the full $50,000 of income. The $20,000 cash distribution itself would not be taxed again, as it is a return of their investment.

Decoding Your Schedule K-1

The Schedule K-1 is organized into three parts. Part I provides the S corporation’s identifying information, such as its Employer Identification Number (EIN), while Part II contains the shareholder’s personal information and ownership percentage. Shareholders should verify that all information in these sections is accurate to prevent processing issues.

Part III details the shareholder’s specific share of the corporation’s financial items. The K-1 will include a statement explaining what each code represents, and shareholders can refer to the official IRS instructions for a complete list. Common entries include:

• Box 1: Ordinary business income (loss) from the company’s main operations.
• Box 2: Net rental real estate income (loss).
• Box 5: Interest income.
• Box 6: Dividends.
• Box 7: Royalties.
• Box 10: Net section 1231 gain (loss) from the sale of business-use assets.
• Box 11: The Section 179 deduction for expensing certain business property.
• Box 12: Other deductions, specified by a code.
• Box 13: Tax credits, which directly reduce a shareholder’s tax liability.
• Box 16: Items affecting shareholder basis, with Code “D” reporting total property distributions.

Reporting K-1 Information on Your Personal Return

Upon receiving a Schedule K-1, you must transfer the reported figures to the appropriate lines and schedules of your personal tax return, Form 1040. Tax preparation software simplifies this process by providing a dedicated section for K-1 entry, which automatically populates the information onto the correct forms.

For those filing manually, the process involves a direct mapping of information. The ordinary business income or loss from Box 1 is reported on Schedule E (Form 1040), as is net rental real estate income from Box 2. Portfolio income items like interest and dividends from Boxes 5 and 6 are reported on Schedule B (Form 1040).

Gains and losses from the sale of property also have specific forms. A net section 1231 gain from Box 10 is carried to Form 4797, “Sales of Business Property.” Net short-term and long-term capital gains or losses found in Box 8 are reported on Schedule D (Form 1040).

Calculating and Tracking Your Shareholder Basis

Shareholder basis represents your total investment in the S corporation, and it is the shareholder’s responsibility to track this figure. The calculation begins with your initial investment, which is the amount of cash and the adjusted basis of any property you contributed in exchange for stock. This initial basis is then adjusted annually.

To adjust your basis, start with the beginning-of-year figure and increase it by your share of the corporation’s income and any additional capital you contribute. Then, decrease the basis by any distributions you receive (reported in Box 16, Code D of the K-1) and your share of the corporation’s losses and deductions. The basis can never be reduced below zero.

Tracking your basis is important for two primary reasons. First, it limits the amount of corporate losses you can deduct on your personal return. You can only deduct losses up to the amount of your basis; any excess loss is suspended and carried forward to future years, where it can be deducted once you have sufficient basis.

Second, your basis determines the taxability of distributions. A distribution that exceeds your basis is treated as a taxable capital gain. For example, if your basis is $5,000 and you receive a $7,000 distribution, the first $5,000 is a tax-free return of capital that reduces your basis to zero, and the remaining $2,000 is taxed as a capital gain.