What Are S Corp Separately Stated Items?
Learn why some S Corp income and deductions are stated separately, impacting each shareholder's tax liability based on their individual financial circumstances.
An S corporation provides business owners with liability protection while allowing company profits and losses to be “passed through” to the owners’ personal tax returns, avoiding corporate-level tax. The S corporation itself generally does not pay income tax; instead, shareholders report their share of the business’s financial results on their individual returns. The tax code requires certain types of income, deductions, and credits to be reported separately from the company’s main operating income. These are known as separately stated items, a concept ensuring that items with special tax characteristics are handled correctly at the individual shareholder level.
Distinguishing Separately Stated and Non-Separately Stated Items
To understand S corporation taxation, one must distinguish between non-separately stated and separately stated items. Non-separately stated items are the revenues and expenses a business incurs in its daily operations, including gross receipts, costs of goods sold, employee salaries, rent, and utilities. These are bundled on Form 1120-S to calculate the company’s ordinary business income or loss.
The reason for separating certain items is that they are subject to rules and limitations that vary among shareholders. The tax treatment of these items depends on a shareholder’s unique financial situation, such as their total income or other investments. If these items were merged into the corporation’s ordinary income, they would lose their special tax character, potentially leading to an incorrect tax calculation.
For instance, some deductions are limited by a taxpayer’s adjusted gross income, while certain types of income are taxed at preferential rates. Reporting these items separately ensures they are applied correctly on each shareholder’s personal return, preserving individual-specific tax rules.
Common Examples of Separately Stated Items
The tax code identifies numerous items that must be stated separately due to their unique treatment on an individual’s tax return. These items are passed through to shareholders and retain their original character. This means a capital gain for the S corporation is treated as a capital gain for the shareholder, not as ordinary business income.
Income & Gains
Several types of income and gains must be reported separately. Net long-term and short-term capital gains and losses are a primary example because they are subject to different tax rates and are used to offset capital losses on a shareholder’s personal return. Section 1231 gains and losses from the sale of business property are also stated separately, as they can be treated as either capital gains or ordinary losses. Portfolio income, such as interest and dividend income, is separated because it is considered investment income, not active business income.
Deductions
Certain deductions have specific limitations at the individual level and must be passed through separately. Charitable contributions made by the corporation are a common example; shareholders must combine these with their personal contributions and apply their own adjusted gross income (AGI) limitations. The Section 179 expense deduction allows for the immediate expensing of qualifying business property and is subject to an overall dollar limit that applies at the shareholder level. Investment interest expense is also stated separately, as its deductibility is limited to a shareholder’s net investment income.
Credits and Other Items
Tax credits, such as the foreign tax credit, are passed through separately because they directly reduce a shareholder’s tax liability. For this credit, the S corporation reports the necessary information on Schedule K-3. Shareholders then use these details to complete Form 1116, Foreign Tax Credit. Other items requiring separate reporting include tax-exempt income and any items that could trigger the alternative minimum tax (AMT) for a shareholder.
How Separately Stated Items are Reported on Schedule K-1
An S corporation uses Schedule K-1 (Form 1120-S) to report each owner’s share of financial items. This document is provided to each shareholder annually and breaks down their pro-rata portion of the company’s ordinary business income and all separately stated items. The K-1 acts as a roadmap, guiding the shareholder on what to report on their personal tax return.
The form uses a series of boxes, each for a specific type of income, deduction, or credit. For example, ordinary business income is in Box 1. Separately stated items are detailed in subsequent boxes; net long-term capital gains are reported in Box 8, and net short-term capital gains are in Box 7.
Other items have their own designated spots. Interest income is in Box 4, while ordinary dividends are in Box 5a. Deductions are also clearly identified. Charitable contributions are detailed in Box 12, and the Section 179 deduction is in Box 11. Reviewing these specific boxes shows the precise amounts and character of each item passed through from the S corporation.
Impact on the Shareholder’s Personal Tax Return
Receiving a Schedule K-1 is the first step in transferring that information to the shareholder’s personal tax return, Form 1040. Each box on the K-1 corresponds to a specific form or schedule. For instance, the ordinary business income from Box 1 is reported on Schedule E, and capital gains and losses from Boxes 7 and 8 flow to Schedule D.
Other items follow a similar path. Dividend income from Box 5a is reported on Schedule B, while charitable contributions from Box 12 are claimed on Schedule A. The Section 179 deduction from Box 11 is calculated on Form 4562 before the allowable amount is carried to the shareholder’s return.
The pass-through system also affects a shareholder’s stock basis, which is their investment in the corporation for tax purposes. Both non-separately stated income and separately stated income items increase a shareholder’s basis. Conversely, corporate losses, deductions, and distributions to the shareholder decrease this basis. Tracking basis is the shareholder’s responsibility and is important because it determines the taxability of distributions and limits the amount of corporate losses a shareholder can deduct.