What the Form Is For

Form 1120-S is the annual tax return that S corporations must file with the IRS to report their income, gains, losses, deductions, and credits. Unlike traditional C corporations that pay corporate income tax, S corporations are "pass-through" entities. This means the corporation itself doesn't pay federal income tax at the corporate level. Instead, all income, losses, and tax benefits flow through to the individual shareholders, who report their proportionate share on their personal tax returns (Form 1040).

Think of it this way: if you and two partners own an S corporation equally, and the business earns $90,000 in profit, each of you would report $30,000 of income on your personal tax return, even if you didn't take that money out of the business. The corporation files Form 1120-S to report the total $90,000, and each shareholder receives a Schedule K-1 showing their individual share.

This form is only for corporations that have elected S corporation status by filing Form 2553 with the IRS and received acceptance of that election. It's designed specifically for small domestic corporations with no more than 100 shareholders, all of whom must be U.S. citizens or residents, and can only have one class of stock. IRS.gov

When You’d Use It (Including Late and Amended Returns)

Regular Filing Deadline: For the 2010 tax year, S corporations generally must file Form 1120-S by March 15, 2011 (the 15th day of the 3rd month after the end of the tax year). If that date falls on a weekend or legal holiday, you can file on the next business day.

Extension: If you need more time, you can request an automatic 6-month extension by filing Form 7004 by the original March 15 deadline. This gives you until September 15, 2011 to file, though remember that an extension to file is not an extension to pay—any taxes owed must still be paid by the original deadline to avoid penalties.

Late Returns: If you miss the deadline, you should still file as soon as possible. The penalty for late filing can be substantial: $195 per month (or part of a month, up to 12 months) multiplied by the number of shareholders. So if your S corporation has three shareholders and files three months late, the penalty would be $1,755 ($195 × 3 months × 3 shareholders).

Amended Returns: If you discover errors after filing, you must file an amended Form 1120-S by checking box H(4) "Amended return" on page 1. Attach a detailed statement explaining what changed and why. You must also file amended Schedule K-1 forms for any affected shareholders and provide them with copies, checking the "Amended K-1" box at the top of each schedule. IRS.gov

Key Rules and Changes for 2010

Several important rules and changes applied specifically to the 2010 tax year:

Start-Up Cost Deduction: For 2010, S corporations could elect to deduct up to $10,000 of start-up costs immediately, rather than amortizing them over 15 years. This was a special provision for tax years beginning in 2010 under Section 195(b)(3).

New Tax Credits: Three new business credits became available in 2010:

• New Hire Retention Credit (Form 5884-B) for retaining certain unemployed workers
• Credit for Small Employer Health Insurance Premiums (Form 8941) for businesses offering employee health coverage
• Qualifying Therapeutic Discovery Project Credit (Form 3468) for certain pharmaceutical research

Electronic Filing Threshold: S corporations with total assets of $10 million or more that file at least 250 returns annually were required to file electronically, though waivers could be requested.

Reporting Requirements: If your S corporation had any involvement with reportable transactions (including certain tax shelters or transactions with contractual protection), you must file Form 8886, or face penalties of up to $200,000 per transaction.

Section 444 Election: S corporations could elect to use a fiscal year (rather than a calendar year) with up to 3 months of deferral by filing Form 8716, though this required annual payments calculated on Form 8752. IRS.gov

Step-by-Step (High Level)

Step 1: Gather Your Records

Collect all financial records for 2010, including income statements, expense receipts, bank statements, payroll records, and documentation for any assets purchased or sold. You'll need accurate beginning and ending inventory figures, depreciation schedules, and records of any distributions made to shareholders.

Step 2: Complete the Income Section (Lines 1-6)

Report gross receipts or sales, then subtract returns and cost of goods sold to arrive at gross profit. Add any other income from Form 4797 (asset sales) or other sources. This gives you your total income for the year.

Step 3: Calculate Deductions (Lines 7-20)

List all ordinary business expenses: officer compensation, salaries and wages, repairs, bad debts, rent, taxes, interest, depreciation, advertising, employee benefits, and other deductions. These must be trade or business expenses—investment-related expenses go elsewhere.

Step 4: Determine Ordinary Business Income (Line 21)

Subtract total deductions from total income. This is your ordinary business income or loss that will flow through to shareholders.

Step 5: Complete Schedule K (Shareholders' Pro Rata Share)

This critical schedule breaks down all income, deductions, and credits by category so shareholders can properly report them. Include rental income, interest, dividends, capital gains, tax credits, and any special items that receive different tax treatment on individual returns.

Step 6: Prepare Schedule K-1 for Each Shareholder

Every shareholder must receive a Schedule K-1 showing their proportionate share of each item from Schedule K. If one shareholder owns 40% of the stock, they receive 40% of all income, losses, deductions, and credits.

Step 7: Complete Balance Sheets and Reconciliation (Schedules L, M-1, M-2)

Schedule L shows your beginning and ending balance sheet. Schedule M-1 reconciles your book income with tax income. Schedule M-2 tracks the Accumulated Adjustments Account (AAA), which determines how much can be distributed tax-free to shareholders. Note: If your total assets are less than $250,000 and total receipts are less than $250,000, you can skip Schedules L and M-1.

Step 8: Calculate Any Corporate-Level Taxes

Although S corporations generally don't pay income tax, they may owe tax on built-in gains, excess passive investment income, or LIFO recapture. Calculate these on line 22 if applicable.

Step 9: Sign, Mail, and Distribute

The return must be signed by a corporate officer (president, vice president, treasurer, or tax officer). Mail it to the appropriate IRS service center based on your location and asset size. Provide each shareholder with their Schedule K-1 by the filing deadline. IRS.gov

Common Mistakes and How to Avoid Them

Mistake #1: Missing the Filing Deadline

Even if no tax is due, failing to file on time triggers automatic penalties multiplied by the number of shareholders. Solution: Calendar the March 15 deadline prominently, or file Form 7004 for an automatic 6-month extension.

Mistake #2: Incorrectly Classifying Expenses

Mixing personal expenses with business deductions, or failing to separate investment expenses from trade or business expenses, creates problems. Solution: Maintain separate bank accounts and credit cards for business use, and understand that investment-related expenses go in Schedule K, not as ordinary deductions.

Mistake #3: Errors in Schedule K-1 Preparation

Failing to issue K-1s to all shareholders, reporting incorrect ownership percentages, or omitting items carries a $100 penalty per K-1. Solution: Maintain an accurate stock ledger showing each shareholder's ownership percentage and any changes during the year.

Mistake #4: Ignoring the Accumulated Adjustments Account (AAA)

The AAA (Schedule M-2) tracks the corporation's undistributed taxable income since becoming an S corporation. Distributions exceeding the AAA may be taxable dividends. Solution: Accurately maintain Schedule M-2 each year to know how much can be distributed tax-free.

Mistake #5: Failing to Report Passive Activity Information

Shareholders need detailed information to apply passive activity loss limitations on their individual returns. Solution: For each separate rental or passive activity, attach statements showing income, expenses, and credits separately.

Mistake #6: Neglecting Built-In Gains Tax

If your corporation converted from a C corporation within the past 10 years and sells appreciated assets, you may owe corporate-level built-in gains tax at 35%. Solution: Track the net unrealized built-in gain on Schedule B, line 6, and calculate any tax owed on line 22a.

Mistake #7: Improper Inventory Valuation

Changing inventory methods without IRS approval or inconsistently applying costing methods causes audits. Solution: Use the same inventory method consistently (FIFO, LIFO, or weighted average) and file Form 3115 if you need to change methods. IRS.gov

What Happens After You File

Immediate Processing

Once the IRS receives Form 1120-S, it's scanned and processed. Most returns are processed within a few weeks, though paper returns take longer than e-filed returns.

Shareholder Reporting

Each shareholder uses their Schedule K-1 to complete their individual Form 1040, reporting their share of the corporation's income, losses, deductions, and credits. The deadline for shareholder returns is typically April 15 (April 18, 2011 for 2010 returns).

Potential Audits

The IRS may select your return for examination. S corporation returns can trigger audits if there are significant losses, unusual deductions, large charitable contributions, or inconsistencies between the corporate return and shareholder K-1s.

Carryover Items

Some items flow through to shareholders but may be limited on their individual returns (passive losses, capital losses, charitable contributions exceeding AGI limits). Shareholders carry these forward on their personal returns.

Estimated Taxes for Next Year

Based on 2010 results, you'll know if the corporation owes any corporate-level taxes (built-in gains, excess passive income) and should make quarterly estimated payments for 2011 if these taxes will exceed $500.

State Filing Obligations

Most states require separate S corporation returns. Some states don't recognize S corporation status and tax the entity as a regular corporation, so check your state's requirements.

Record Retention

Keep the filed return and all supporting documentation for at least three years from the filing date. Keep records verifying property basis indefinitely, as they're needed to calculate gain or loss when assets are sold. IRS.gov

FAQs

1. Do I need to file Form 1120-S if my S corporation had no income or expenses this year?

Yes. As long as your S corporation election is in effect, you must file Form 1120-S annually, even with zero activity. Failure to file can result in penalties and may jeopardize your S corporation status. If the corporation is truly inactive and you want to close it, you should properly dissolve it under state law and file a final return.

2. What's the difference between distributions and wages for shareholder-employees?

This is crucial: shareholder-employees who work for the corporation must receive reasonable compensation reported on Form W-2, subject to payroll taxes. Distributions (reported in Schedule K, line 16d) are not subject to employment taxes. The IRS closely scrutinizes S corporations that pay minimal wages but large distributions to owner-employees, as this avoids payroll taxes. Pay yourself a reasonable salary first based on the work you perform.

3. Can my S corporation have a fiscal year instead of a calendar year?

Generally, S corporations must use a calendar year (ending December 31) unless they can establish a business purpose for a different year-end or make a Section 444 election allowing up to three months of deferral. The Section 444 election requires filing Form 8716 and making annual payments on Form 8752 to compensate for the tax deferral benefit.

4. What happens if my S corporation election is accidentally terminated?

Termination can occur if you exceed 100 shareholders, add an ineligible shareholder (like a corporation or nonresident alien), or create a second class of stock. If this happens, notify the IRS immediately. You may qualify for "inadvertent termination relief" under Section 1362(f), allowing you to maintain S status if you correct the problem promptly and can show the termination wasn't intentional.

5. Do I need to complete Schedules L, M-1, and M-2?

It depends on your size. For 2010, if your corporation's total receipts and total assets are both less than $250,000, you can skip Schedules L and M-1. However, Schedule M-2 (Accumulated Adjustments Account) should always be completed because it's essential for determining the tax treatment of distributions to shareholders.

6. Where do I mail my completed Form 1120-S?

For 2010, the mailing address depends on your principal business location and total assets. If you're located in the eastern or midwestern U.S. and have total assets under $10 million (and aren't filing Schedule M-3), mail to Cincinnati, OH 45999-0013. Otherwise, mail to Ogden, UT 84201-0013. International filers use Ogden, UT 84409. Check the current instructions as these addresses can change.

7. Can I e-file my S corporation return?

Yes, electronic filing is available and encouraged for Form 1120-S. If your corporation has $10 million or more in assets and files at least 250 returns annually, e-filing is mandatory. E-filing is faster, more secure, and you receive confirmation of receipt. Many tax software packages support S corporation e-filing, or your tax preparer can file electronically on your behalf.

Sources

All information is sourced from official IRS publications:

• 2010 Form 1120-S Instructions
• 2010 Form 1120-S
• IRS Form 1120-S Information Page

This guide is for informational purposes and reflects 2010 tax law. Always consult the current year's instructions and consider seeking professional tax advice for your specific situation.