1120 S Corp: Everything You Need to Know
1120 S Corp is the form your S Corp will fill out every year for tax purposes. While the corporation doesn’t file corporate income tax, it will need to file Form 1120, an informational tax return that is part of the Schedule K-1 document.3 min read
1120 S Corp is the form your S Corp will fill out every year for tax purposes. While the corporation doesn’t file corporate income tax, it will need to file Form 1120, an informational tax return that is part of the Schedule K-1 document.
Since an S Corp doesn’t pay corporate income taxes, the company passes through all profits and losses to the shareholders (owners) who report it on their personal income tax returns. While the shareholders report such profits and losses, the S Corp will still need to file Form 1120 and report the percentage of shares owned by each shareholder. This percentage is what determines the amount of profits/losses reported by each person.
The percentage could change throughout the year, particularly if shares are purchased, sold, or transferred to someone else. Also included on Form 1120S are deductions and credits from the S Corp. You can find this document on the IRS website.
S Corp Taxation Benefits
One of the biggest benefits of operating an S Corp is the fact that the shareholders need not pay self-employment tax on their share of the company’s profits. Shareholders who are also employees of the business will need to pay themselves a reasonable salary, which is subject to Social Security and Medicare taxes. The self-employment savings will take effect after the S Corp is earning enough money so that there are still profits to be paid out after the reasonable compensation was paid to all shareholders/employees.
For example, let’s assume that John is the sole owner of an S Corporation. His revenues are $50,000/year, and his annual expenses cost him $20,000. His net profits equal $30,000. John wants to pay himself a salary of $15,000 and use the remaining $15,000 as profit; if he does this, he saves himself on self-employment tax in the amount of $15,000 since he is retaining $15,000 as profit in the company. Keep in mind that the IRS might not deem $15,000 to be a reasonable compensation, and therefore, John might have to pay himself $30,000 as a reasonable salary, leaving his business with no profit.
Reasonable Salary Factors
The question here is, “What constitutes a reasonable salary?” This is a common question that leads to legal disputes between the S Corp shareholders and the IRS, as the S Corp shareholder’s goals are the same – they want to avoid additional self-employment tax by paying themselves a lower salary to reduce their tax implications. The way in which shareholders can still earn more money is to pay themselves dividends, which are tax-free.
The court generally considers the following factors when determining reasonable compensation:
• Duties and responsibilities of the shareholder/employee
• The level of training and professional experience that the person has
• The amount of time that the person puts into his or her work for the business
• What other people make in the same industry for similar services
• The compensation paid to non-shareholder employees for similar work
• How much money is paid through dividends to the shareholder/employee, particularly compared to the compensation being paid to this person
Filling out Form 1120S
You will need to provide general information regarding your business, including the following:
• Date when your S election took effect
• Business activity code
• Employer Identification Number (EIN)
• Date of incorporation
You will need to calculate the business’s profits and losses for the taxable year on this form. You will also include all information relating to deductions and credits. Schedule K-1 will need to be filled out for each shareholder, identifying the percentage of their shares in the business. Thereafter, this form will be provided to the shareholder so that he or she is aware of what to report on their personal income tax return.
This form has a schedule B that will also need to be filled out. It consists of 13 questions requiring a yes or no response. These questions relate to what other businesses have an interest in the S Corp and whether or not compensation was paid to independent contractors who would need to fill out IRS Form 1099.
If you need help learning more about the S Corp tax process, or need help filling out Form 1120, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5-percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law, and average 14 years of legal experience, including work with, or on behalf of companies like Google, Menlo Ventures, and Airbnb.