11.14 Stockholder Reporting of S Corporation Income and Loss

S corporations are subject to tax reporting rules similar to those applied to partnerships. However, shareholders who work for the corporation are treated as employees for payroll tax purposes. The IRS and the courts require that S corporation shareholders receive reasonable compensation on which Social Security and Medicare taxes (FICA) must be paid. Self-employment tax does not apply to a shareholder’s salary or similar receipts from the S corporation.

Your company must give you a copy of Schedule K-1 (Form 1120-S), which lists your share of income or loss, deductions, and credits that must be reported on your return. For example, your share of business income or loss is reported on Schedule E and is subject to passive activity adjustments, if any. Interest and dividends from other corporations are reported on Schedule B, capital gains and losses on Schedule D, Section 1231 gains or losses on Form 4797, and charitable donations on Schedule A. Tax preference items for alternative minimum tax purposes are also listed.

Health insurance premimums paid by an S corporation for more-than-2% stockholders are treated as wages, deductible on Form 1120-S by the corporation and reported to the stockholder on Form W-2. A more-than-2% shareholder who reports premiums as wages may deduct the premiums on Line 29 of Form 1040 as an adjustment to income.

Allocation to shareholders.

The following items are allocated to and pass through to the shareholders based on the proportion of stock held in the corporation:

• Gains and losses from the sale and exchange of capital assets and Section 1231 property, as well as interest and dividends on corporate investments and losses. Investment interest expenses subject to the rules discussed in Chapter 15 (15.10) also pass through.
• Tax-exempt interest. Tax-exempt interest remains tax free in the hands of the stockholders but increases the basis of their stock. Dividends from other companies may qualify for the exclusion.
• First-year expense deduction (Section 179 deduction).
• Charitable contributions made by the corporation.
• Foreign income or loss.
• Foreign taxes paid by the corporation. Each stockholder elects whether to claim these as a credit or deduction.
• Tax preference items.
• Recovery of bad debts and prior taxes.

If your interest changed during the year, your pro rata share must reflect the time you held the stock.

Planning Reminder

Basis Limits Loss Deductions

Deductible losses may not exceed your basis in S corporation stock and loans to the corporation. If losses exceed basis, the excess loss is carried over and becomes deductible when you invest or lend an equivalent amount of money to the corporation. This rule may allow for timing a loss deduction. In a year in which you want to deduct the loss, you may contribute capital or make an additional loan to the corporation. If a carryover loss exists when an S election terminates, a limited loss deduction may be allowed.

- - - - - - - - - -

Passive activity rules limit loss deductions.

Losses allocated to you may be disallowed under the passive activity rules discussed in Chapter 10.

Basis adjustments.

Because of the nature of S corporation reporting, the basis of each shareholder’s stock is subject to change. Basis is increased by the pass-through of income items and by loans to the S corporation for which the shareholder is personally liable, and basis is reduced by the pass-through of loss items and the receipt of certain distributions. Because income and loss items pass through to stockholders, an S corporation has no current earnings and profits. An income item will not increase basis, unless you actually report the amount on your tax return. The specific details and order of basis adjustments are listed in the instructions to Schedule K-1 of Form 1120S.