What Is Non-Separately Stated Income?
For pass-through business owners, understand how ordinary net income is calculated and flows from the entity to your personal return, impacting your tax liability.
Businesses structured as S corporations or partnerships operate under a pass-through taxation model, meaning the business itself does not pay federal income tax. Instead, profits and losses are “passed through” to the owners, who report this financial activity on their personal tax returns. The Internal Revenue Code requires that a business’s financial activities be categorized to ensure different types of income and expenses are treated correctly.
Defining Non-Separately Stated Income
Non-separately stated income represents the net profit from the primary, everyday business activities of a pass-through entity. It is the income left after subtracting the ordinary costs of doing business from the gross receipts generated by the company’s main operations. This figure is often referred to as ordinary business income because it excludes any items that are subject to special tax rules or limitations on an owner’s personal return.
The distinction becomes clearer when contrasted with separately stated items. These are specific types of income, losses, deductions, and credits that are not included in the ordinary income calculation because they might be treated differently for each owner. The tax impact of these items depends on an individual owner’s specific financial situation, so the business must report these items individually to each owner.
Common examples of non-separately stated items combined to calculate ordinary business income include the company’s gross sales and receipts, cost of goods sold, employee salaries and wages, rent payments, utilities, and general office expenses. These all relate directly to the day-to-day function of the business.
On the other hand, separately stated items must be pulled out of the ordinary income calculation and reported independently. This category includes net long-term and short-term capital gains and losses, Section 179 deductions, charitable contributions made by the business, and dividend income. These items are subject to different tax rules on an individual’s return.
Calculating Net Business Income
The calculation of non-separately stated income is a process of aggregation and subtraction performed at the business level. It begins by totaling all revenue from the entity’s ordinary trade or business activities. This includes sales of products or services but excludes income sources that have special tax characteristics, such as investment income. Once revenue is compiled, the next step is to subtract all ordinary and necessary business expenses to determine the net profit or loss.
For instance, imagine a small consulting firm structured as an S corporation. It generates $500,000 in client fees during the year. Its ordinary expenses include $200,000 in employee salaries, $60,000 in office rent, and $15,000 in utilities. The non-separately stated income would be calculated as $500,000 (Revenue) – $275,000 (Total Expenses), resulting in $225,000 of ordinary business income.
This calculation is performed before any distributions are made to the owners. The resulting net income figure is what will ultimately be passed through to the owners for tax purposes. It is a pure reflection of the operational profitability of the business itself, stripped of any financial activities that require special consideration on an individual’s tax return.
Reporting and Tax Treatment for Owners
After the non-separately stated income is calculated, the business reports this figure on its informational tax return. For partnerships, this is done on Form 1065, U.S. Return of Partnership Income, and for S corporations, the corresponding form is Form 1120-S, U.S. Income Tax Return for an S Corporation. This amount is then allocated to the owners based on their percentage of ownership in the company.
Each owner receives a Schedule K-1, which details their specific share of the company’s income, deductions, and credits for the year. The non-separately stated income, or ordinary business income, is reported in Box 1 of the Schedule K-1. This document links the business’s tax return and the owner’s personal tax return.
The owner then takes the amount from Box 1 of their Schedule K-1 and reports it on Schedule E of their personal tax return, Form 1040. The income is taxed at the owner’s individual marginal tax rate.
This income may also be subject to self-employment taxes for general partners or members of an LLC that is taxed as a partnership. Furthermore, this ordinary business income figure is a component in determining an owner’s eligibility for the Qualified Business Income (QBI) deduction under Section 199A.