How to Prepare S Corporation Returns (Form 1120S): A Beginner’s How to Guide
Lifting the veil behind the confusion of tax returns is an important part of the relationship with your CPA. The more a business owner knows about preparing corporate income taxes the better suited they will be in providing what will be needed. The initial step, in any well-thought out preparation process is to first obtain all of the information that will be required to complete the returns. For example on our web site www.hiscpa.com/newclient.html you will find a listing of all of the information that will be required to prepare the year-end corporate income taxes. The most critical part of this process is to obtain a Balance Sheet and Profit & Loss for the year being sure to include an adequate chart of accounts to properly reflect items on the tax return as well as to manage the financial decisions of the business. The tax form to be filed for an S Corporation is Form 1120S and the corresponding form to the state of Georgia is Form 600S. Corporate income tax returns are due March 15th of each year or seventy-five days after the end of the company’s tax year. This due date would relate to LLC’s who have filed a tax election to be taxed as an S Corporation as well.
To help illustrate how to properly prepare a Form 1120S, especially the Taxable Portion of the return, let’s assume an example we’ll call the ABC Company with the below Profit and Loss (prepared on a cash basis):
Sales $200,000
Purchases 80,000
Independent Contractors 10,000
Total Cost of Goods Sold 90,000
Gross Profit/Margin 110,000
Salaries - Owner 70,000
Payroll Taxes 7,000
Section 179 Depreciation 10,000
Meals & Entertainment 4,000
Contributions 1,000
Office Supplies 10,000
Legal & Professional Fees 2,000
Net Income $ 6,000 *
*No provision for income taxes are to be recorded on an S Corporation Internal books as an S Corporation does not pay income taxes. Instead those earnings flow down to the owners of the company who pay taxes on accordingly on their respective Form 1040/their personal return.
The major tenants of the form are and how the Profit and Loss of ABC Company would be reflected on the Form 1120S are predicated on the above assumptions following:
Corporate Name and Identifying Information.
This will include the company’s full physical address (not a P.O. Box), the Federal ID # or EIN, date of incorporation and date that the IRS accepted the company’s S Corporation election (which is obtained by filing of Form 2553 within seventy-five days of the tax year to which the election relates). Also noted at the beginning of the return is a notation of whether the return is the first or final return filed, if the return has been amended and acknowledgment of any address change. Here ABC Company would lists its name, address, ID#, date the company was incorporated as well as the date S Corporation status was formally accepted by the IRS.
Reporting of Income
Gross Receipts of the business are listed on page one of the return with any corresponding reduction reflected for any returns and allowances. If your corporation is located solely within one state, doing business in several states or worldwide all of the corporate income is listed on Line 1a of the return. Here ABC Company would lists its Sales of $100,000.
Cost of Goods Sold
Cost of Goods Sold are detailed on Schedule A of Form 1120S detailing the opening and ending inventory for the year, purchases, cost of labor, other direct costs, and Section 263A (which is an allocation, if required, of any applicable overhead costs). Here ABC Company would lists its Purchases of $80,000 and Contract Labor of $10,000 detailing a $90,000 Total Cost of Goods Sold per the return.
Gross Profit
Perhaps the most significant indicator of the likelihood of corporate profits is the amount of gross profit or margin that a company reflects for the year. Care should be taken at all levels of management and personnel alike to ensure that an adequate gross profit in terms of both dollars and percent is achieved on each and every single billing done during the year. Managing this percentage is critical to influencing what the final profit for the year will be. Here ABC Company would lists its Gross Profit Margin of $110,000 which is calculated by subtracting their Cost of Goods Sold of $90,000 from their Sales of $200,000.
Salaries
Salaries are broken down between on the return between Officers, Other salaried personnel, and payroll taxes thereon. Usually apart from Cost of Goods Sold these are the second largest dollars listed on the return. Care should be exercised to ensure that these accounts are similarly reflected on a company’s internal profit and loss as well. Here ABC Company would lists its Salaries to its owner of $70,000.
Repairs & Maintenance, Rents, Taxes & Licenses, Interest, Depreciation, Advertising, Pension Cost, Employee Benefit Plans and Meals & Entertainment.
Repairs & Maintenance, Rents, Taxes & Licenses, Interest, Depreciation, Advertising, Pension Cost, and Employee Benefit Plans are listed as separate line items on the first page of the return. Here ABC Company would lists its Payroll Taxes of $7,000. Section 179 Depreciation of $10,000 would not be listed here as it is a tax preference item which will be reflected on the K-1 schedule which will be attached to the Form 1102S indicating to all owners their respective share of tax preference items. Meals & Entertainment of $4,000 would also be listed here but, per tax law, this amount would be reduced to $2,000 as only one-half of Meals & Entertainment are tax deductible.
Other Deductions
As an attachment to the return, Other Deductions are listed detailing other substantive expense items such as Office Supplies, Insurance, Travel, Telephone & Utilities and Legal & Professional Fees. Here ABC Company would lists its Office Supplies of $10,000 and Legal & Professional Fees of $2,000. On the return the company will reflect Total Other Deductions of $12,000.
Ordinary Income (Loss)
Ordinary income (loss) reflects the Gross Margin less all of the subsequently listed expenses. Here ABC Company would lists its Ordinary Income (per the tax return) of $19,000 (calculated by taking the Gross Profit Margin of $110,000 and subtracting from it $70,000 of Salaries to the Owner, $7,000 of Payroll Taxes, the deductible portion of Meals & Entertainment of $2,000, and total Other Deductions (described above) of $12,000). All of us, upon first glance would initially ask the question, why is the cash based profit of $6,000 above now increased to the $19,000 as listed on the return? To help clarify this difference please see the below reconciliation:
Cash Based Net Income Per the Company P & L $ 6,000
Add Meals and Entertainment (fifty percent deductible) 2,000
Add Section 179 Depreciation (a tax preference item)** 10,000
Add Contributions, which are also tax preference item 1,000
Taxable Income Per the Return $19,000
**For Fixed Assets that qualify (up to certain statutory tax limits and further limited by the amount of profit of the business) ABC Company can write off in full, in the year purchased, qualifying fixed assets. In this example the $10,000 is below the IRS allowable limits and the company still has a profit after considering the Section 179 deduction. Section 179 Depreciation is a tax preference item and therefore not listed on the face of the Form 1120S. However it is reflected on the K-1 schedule attached to the return for the owner to accordingly reflect as a tax deduction on their personal return (assuming the individual taxpayer meets qualifying parameters that are applicable).
Income Taxes
As an S Corporation is a “flow through entity” all of the earnings from the corporation flow down to the returns of the shareholders who own the company stock. It is there on the personal returns that the S Corporation shareholders reflect the operating results and pay the income taxes that are owed on S Corporation earnings. As these monies flow down to the individual owners/taxpayers return (Form 1040), there are no income taxes due to the IRS on the filing of the Form 1120S/the corporate income tax return for S Corporations. When the GA S Corporation return (Form 600S) is filed there are no income taxes due GA, as well, as the earnings are reported on the GA owners return (regardless of whether you are a resident of GA or a non-resident). However there is a modest net worth tax due the State of GA, which is based upon a company’s net worth (per the Balance Sheet) at the end of the year. Here ABC Company would lists no income taxes as the corporation is a “flow through entity” on the Form 1120S and all profits and tax preference items will appear on the appropriate forms and sections of the shareholders personal income tax return (Form 1040).
Tax Method & Business Activity
A company’s method of the filing of its income tax returns, whether cash, accrual, percentage-of-completion or completed contract are reflected on the return. Generally all companies with inventory would file on an accrual basis to ensure that cost of purchases of items still in inventory are not unduly expensed. Otherwise, typically it is tax advantageous to file your tax return on a cash basis, assuming you qualify. Also in this section of the return the Business Activity of the return is shown as to whether the items sold of the company are a product or a service. Here ABC Company would list that it is a cash basis taxpayer detailing the business that it does.
Tax Preference Items
As all of the earnings flow down to the respective owners of an S Corporation to their individual returns so do any tax preference items such as interest income, contributions and Section 179 depreciation so that owners may reflect in the correct locations of their personal returns these respective items. Here ABC Company would delineate the Section 179 Depreciation of $10,000 and Contributions of $1,000.
Balance Sheet
On Form 1120S there is a section of the return to reflect the Balance Sheet for the current and the prior year. Here all of a company’s current assets, long term assets (such as fixed assets), current and long term liabilities, common stock, additional paid-in-capital, and retained earnings are reflected. Supporting schedules, if needed, to substantiate the balance listed are also frequently shown. Here ABC Company would detail and list its Balance Sheet accounts as of the close of the last two taxable years.
Reconciliation of Income (Loss) per Books With Income (Loss) per Return
Here a schedule is performed which details and reconciles book income to taxable income as delineated on the return detailing any timing or permanent tax differences. Here ABC Company would detail (as per the above reconciliation) how the company’s internal Profit & Loss reconciles to the Taxable Income as reflected on the return (Form 1120S).
Analysis of Accumulated Adjustments Account & Shareholder’s Undistributed Taxable Income
This schedule is on the page of the Form 1120S and reconciles all adjustments to the retained earnings account including the amount of taxable income (loss) and netting those against shareholder distributions. S Corporation owners pay taxes on all the company’s earnings “when they make the profit, rather than when the profit is distributed.” For example if a company has in a given year $100,000 of taxable profit, then the owners would pay tax on the $100,000 in the year the money is made, rather than the year when a shareholder distribution for these monies are made to the company’s owners. Here ABC Company would detail the roll forward of the prior year retained earnings account to the current year balances reflecting the taxable income of $19,000, tax preference items, any non-deductible (for tax purposes) business expenses and shareholder distributions.
Helping to remove the mystique of income tax return preparation and helping to educate our client base is our watchword. A well-informed client is our goal so that we might closely work together to do what we legally might to keep your tax bill as low as legally possible. For articles relating to the above issues and to learn more please see:
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Written by John Dillard CPA of His CPA at 770 814 9304 and visit www.HisCPA.com (a Atlanta Christian CPA firm). At His CPA we march to the beat of a higher drummer where we put the “Golden Rule” to work each and every day by “Serving Him by Serving You…One Tax Return at a Time.” We advise clients on: IRS representation, Offer in Compromise, Incorporation in GA, Corporate and Personal Income Tax Returns, Part-time CFO, Virtual Controller, Business Planning, Payroll Administration, Bookkeeping.
We serve clients that are located in Atlanta GA, Gwinnett County, North Fulton County, DeKalb County, Hall County, Clayton County, Cobb County, Forsyth County, Hart County, Jefferson County, Duluth, Alpharetta, Johns Creek, Lawrenceville, Milton, Norcross, Snellville, Roswell, Buford, Cumming, Grayson, Hartwell, Suwanee, Sugar Hill, Loganville, Lilburn, Dunwoody, Gainesville, Decatur, and Beyond.
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