S Corp K1 Explained: From Form to Tax Return

An S corporation provides its owners with a Schedule K-1 (Form 1120-S) each year. As a pass-through entity, an S corp does not pay federal income tax at the corporate level. Instead, its profits, losses, deductions, and credits flow through to the individual shareholders, and the K-1 reports each shareholder’s specific share of these items.

This form allocates the corporation’s financial results based on each owner’s percentage of stock ownership. Shareholders are liable for tax on their portion of the corporation’s income, regardless of whether the company actually distributed any cash to them. The information on the Schedule K-1 is then used by each shareholder to complete their personal income tax return, Form 1040.

Understanding the Information on Your Schedule K-1

The Schedule K-1 is organized into three main parts. Part I provides identifying information about the S corporation, such as its name, address, and Employer Identification Number (EIN).

Part II focuses on the shareholder, detailing your name, address, and taxpayer identification number. This section also specifies your percentage of stock ownership for the tax year, which dictates the portion of the corporation’s financial activity allocated to you.

Part III is the most detailed section, itemizing your share of the corporation’s current year income, deductions, and other financial items. Box 1 reports your share of ordinary business income or loss, which is the primary profit or loss from the company’s main operations. If the corporation has rental activities, your share of that net income or loss is reported in Box 2. Other boxes detail different types of portfolio income, which are separated because they are often taxed at different rates.

• Box 4 shows your share of interest income.
• Box 5 reports dividend income.
• Box 6 lists any income from royalties.
• Box 7 contains net short-term capital gains or losses.

Deductions and credits that pass through to you are also specified in Part III. Box 11 details your portion of the Section 179 deduction, which allows for the immediate expensing of certain business property. Box 12 is used for other deductions, and Box 13 reports various tax credits, identified by a code. Box 16 reports items that affect your shareholder basis, with distributions of cash and property being a primary item reported here.

Shareholder Basis and Distributions

A shareholder’s basis is a measure of their economic investment in the S corporation. It is a running tally that determines the tax consequences of distributions and the deductibility of losses. You are responsible for tracking your own basis, and the starting point is your initial capital contribution or the price you paid for the stock.

Each year, your basis is adjusted. It increases by your share of the corporation’s income and gains, including tax-exempt income. Your basis decreases by any corporate distributions you receive and by your share of the corporation’s losses and deductions. This calculation is performed at the end of the corporation’s tax year.

The income reported on your K-1 represents your share of the company’s profits, and you are taxed on this amount whether you receive it or not. A distribution, reported under Box 16, is an actual payment of cash or property from the corporation to you.

The tax treatment of a distribution depends on your basis. If your basis is greater than the amount of the distribution, the distribution is a tax-free return of your investment and reduces your basis. For instance, if your basis is $20,000 and you receive a $12,000 distribution, that $12,000 is tax-free, and your new basis is $8,000. If a distribution exceeds your basis, the excess amount is treated as a taxable capital gain.

Using Your K-1 on Your Personal Tax Return

The information from your Schedule K-1 must be transferred to the correct locations on your personal tax return, Form 1040, and its associated schedules. The IRS provides instructions for the K-1 that specify where each item should be reported.

The amounts from the most common K-1 boxes flow to specific forms. Ordinary business income or loss from Box 1 and rental real estate income from Box 2 are reported on Schedule E (Form 1040). Portfolio income items are handled on different schedules. Interest income from Box 4 and dividend income from Box 5 are reported on Schedule B, while capital gains or losses are carried over to Schedule D.

Certain deductions require their own forms before the final amount is transferred to your Form 1040. For example, the Section 179 deduction from Box 11 must first be reported on Form 4562, Depreciation and Amortization.