Who Must File Form 1120‑S (and Who Can Be an S‑Corp)

• S‑corporations pass corporate income, losses, deductions, and credits through to shareholders; the entity files Form 1120‑S and issues Schedule K‑1s to each shareholder. S corporations

• To be an S‑corp, a domestic corporation (or an eligible entity that elects to be treated as a corporation) must timely file Form 2553 and meet the S‑eligibility rules (for example, no more than 100 shareholders, one class of stock, and only allowable shareholders). Instructions for Form 2553 • S corporations

• LLCs can choose corporate or S‑corporation status: a multi‑member LLC defaults to a partnership but may elect to be treated as a corporation (and then an S‑corp) by filing Form 8832 (and Form 2553); a single‑member LLC is disregarded unless it elects corporate status (and then S‑corp). LLC filing as a corporation or partnership • Form 8832 • Instructions for Form 2553

When and How to File

• Due date: Form 1120‑S is generally due by the 15th day of the 3rd month after the end of the tax year (March 15 for calendar‑year S‑corps). Extensions are available via Form 7004. 2024 Instructions for Form 1120‑S • Publication 509

• E‑file mandate: If your business files 10 or more returns of any type in the calendar year, you are required to e‑file Form 1120‑S (returns required to be filed on or after January 1, 2024). Waiver procedures exist for hardship. 2024 Instructions for Form 1120‑S

• Schedule K‑2/K‑3: If the S‑corp has certain foreign‑related items, you may need to file Schedules K‑2/K‑3 with the 1120‑S and furnish K‑3s to shareholders (domestic filing exception may apply). S corporations • 2024 S Corporation Instructions for Schedules K‑2 and K‑3

What Goes on Form 1120‑S and Schedule K‑1

• Form 1120‑S reports entity‑level income, deductions, credits, and other items. 2024 Instructions for Form 1120‑S

• Schedule K‑1 shows each shareholder’s share of pass‑through items and certain other information (for example, items affecting basis) that shareholders must report on their own returns; Schedule K‑1s are furnished to shareholders and filed with the IRS. 2024 Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S)

• Important: Dividends paid from accumulated earnings & profits (AE&P) aren’t reported on Schedule K‑1. They are reported to shareholders on Form 1099‑DIV and sourced under special ordering rules if the S‑corp has AE&P from C‑corp years. 2024 Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S) • 2024 Instructions for Form 1120‑S

Shareholder‑Level Limitations—And Why Basis Tracking Is Non‑Negotiable

Before a shareholder deducts S‑corp losses or takes tax‑free distributions, four layers of rules may limit the outcome. Apply them in order:

• Basis limitations (stock and debt basis) 2024 Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S)

• At‑risk limitations Publication 925

• Passive activity limitations Publication 925

• Excess business loss limitations (noncorporate taxpayers) Publication 925

• Basis limitations: Losses and deductions flow through only to the extent of the shareholder’s stock basis plus the basis of any bona fide debt of the S‑corp to the shareholder. Stock/debt basis is increased/decreased annually; shareholders generally use Form 7203 to compute and track basis annually. Debt basis is not created by guarantees or co‑borrowing until the shareholder actually makes payment and becomes the creditor. 2024 Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S) • Instructions for Form 7203

• At‑risk rules: Loss deductions may be further limited to the amount “at risk” under section 465; shareholders often must file Form 6198 if they have amounts not at risk. Publication 925 • Instructions for Form 6198

• Passive activity rules: Passive losses may be limited under section 469; see Form 8582/8582‑CR and Pub. 925 for material participation tests and special rules. Publication 925 • 2024 Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S)

Key Basis Practices

• Basis increases first for income, then decreases for distributions, then nondeductible expenses, then losses/deductions; this “ordering” affects the taxability of distributions and the ability to deduct losses. Instructions for Form 7203

• Loan guarantees do not create debt basis; basis arises when the shareholder actually pays the guaranteed debt and thereby becomes a creditor of the corporation. Instructions for Form 7203 • 2024 Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S)

Distributions, AAA, AE&P, and When a K‑1 Distribution Becomes Taxable

• AAA (Accumulated Adjustments Account) tracks previously taxed S‑corp income and can go negative; it governs ordering of certain distributions. In general (for S‑corps with AE&P), distributions are deemed to come from AAA, then any previously taxed income if applicable, then AE&P (taxable dividend), then other accounts; ordering rules include special net negative adjustments. 2024 Instructions for Form 1120‑S

• Non‑dividend distributions reduce stock basis; to the extent a distribution exceeds stock basis, it is a capital gain to the shareholder (reportable on Form 8949/Schedule D). Basis is not reduced below zero. Instructions for Form 7203 • 2024 Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S)

• If the S‑corp has AE&P (from prior C‑corp years or certain reorganizations), distributions beyond AAA can be taxable dividends (reported on Form 1099‑DIV). S‑corps must get the ordering right on the return and in shareholder reporting. 2024 Instructions for Form 1120‑S

Reasonable Compensation (W‑2) Before Distributions

• S‑corp officers who provide more than minor services and receive (or are entitled to) pay are employees; wages must be reasonable for services rendered and reported on Form W‑2. Paying owners only via “distributions,” “draws,” or “loans” while performing services is a red flag that can trigger recharacterization and employment tax assessments. Paying yourself (S corporations)

• Practical note: The IRS looks at training/experience, duties/responsibilities, time/effort, comparable pay, dividend history, and other facts to assess “reasonable compensation.” S corporations

Retirement Plan Contributions: Distributions Don’t Count as “Compensation”

• You cannot make 401(k) or self‑employed plan contributions based on S‑corp shareholder distributions; only W‑2 wages are eligible “compensation.” Contributions based on distributions must be corrected. S corporations

The Most Common—and Costly—S‑Corp Filing Mistakes

• Failing to file on time or to e‑file when required
  Late or paper filing when you meet the e‑file threshold can trigger penalties and compress shareholder reporting timelines. Calendar‑year 1120‑S returns are generally due March 15; request a Form 7004 extension if needed. 2024 Instructions for Form 1120‑S • Publication 509

• Treating owner distributions as a substitute for wages
  Officers performing services must receive reasonable W‑2 compensation; recharacterization risks include back employment taxes and penalties. Paying yourself (S corporations)

• Not tracking shareholder basis and not filing Form 7203
  Basis determines whether losses are deductible and whether distributions are tax‑free or capital gain. Guarantees do not create basis; payment by the shareholder does. Instructions for Form 7203 • 2024 Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S)

• Misclassifying distributions when the S‑corp has AE&P
  If the S‑corp has accumulated earnings & profits (for example, from C‑corp years), distribution ordering must be analyzed: AAA → AE&P (dividend) → other. Taxable dividends must be reported on Form 1099‑DIV, not on Schedule K‑1. 2024 Instructions for Form 1120‑S • 2024 Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S)

• Ignoring at‑risk and passive activity limits
  Even with basis, losses may be limited by the at‑risk and passive activity rules; shareholders frequently need Form 6198 and Form 8582. Failure to apply these can lead to disallowed losses and notices. Publication 925 • Instructions for Form 6198 • 2024 Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S)

• Pension/401(k) contributions based on distributions
  Only W‑2 wages count as “compensation” for plan contributions. Contributions based on distributions must be corrected. S corporations

• Misunderstanding loan basis (versus guarantees or co‑borrowing)
  Debt basis requires bona fide indebtedness running directly from the S‑corp to the shareholder. Guarantees or co‑borrowed bank loans don’t create basis until the shareholder pays and becomes the creditor. Instructions for Form 7203 • 2024 Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S)

• Missing or incorrect Schedule K‑2/K‑3 reporting
  If the S‑corp has foreign‑related items, K‑2/K‑3 may be required. Failure to furnish K‑3s timely complicates shareholder foreign tax credit reporting (note domestic filing exception criteria). 2024 S Corporation Instructions for Schedules K‑2 and K‑3

• Not furnishing accurate K‑1s (or furnishing dividend amounts on K‑1)
  K‑1s report pass‑through items and basis adjustments; dividend distributions are separately reported via Form 1099‑DIV and should not be shown on K‑1. 2024 Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S)

Quick Compliance Checklist for Owners

• Elect (or confirm) S‑status: Form 2553 timely filed; LLCs also file Form 8832 if needed. Instructions for Form 2553 • LLC filing as a corporation or partnership

• Run reasonable owner wages via payroll and issue W‑2s before distributions. Paying yourself (S corporations)

• File Form 1120‑S by the due date (March 15 for calendar‑year filers) and e‑file if required. 2024 Instructions for Form 1120‑S • Publication 509

• Provide accurate Schedule K‑1s (and K‑2/K‑3 if applicable) to shareholders. 2024 Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S) • 2024 S Corporation Instructions for Schedules K‑2 and K‑3

• Each shareholder completes Form 7203 annually to track basis; maintain support for any debt basis. Instructions for Form 7203

• Apply at‑risk and passive rules (Forms 6198 and 8582 as needed). Publication 925 • Instructions for Form 6198

• If the S‑corp has AE&P, determine distribution ordering and issue any necessary 1099‑DIVs for dividend portions. 2024 Instructions for Form 1120‑S

• Ensure retirement plan contributions are based on W‑2 wages—not distributions. S corporations

Appendix: The Legal Backbone You’ll Rely On

• S‑corp reporting and deadlines: 2024 Instructions for Form 1120‑S • Publication 509 • S corporations

• Basis and loss limits: Instructions for Form 7203 • 2024 Shareholder’s Instructions for Schedule K‑1 (Form 1120‑S)

• AAA and distributions: 2024 Instructions for Form 1120‑S

• At‑risk and passive rules: Publication 925 • Instructions for Form 6198

• Reasonable compensation and payroll: Paying yourself (S corporations) • S corporations

Getting Form 1120‑S and Schedule K‑1 right requires strong controls over payroll (reasonable owner W‑2s), distributions (AAA/AE&P ordering and basis impact), and shareholder‑level compliance (Form 7203, at‑risk, passive). If you’d like a second set of eyes on your specific fact pattern, our S‑corp advisory team can help you implement a defensible, audit‑ready process grounded in the rules above. S corporations