How Does an S Corp Determine Profit or Loss?

• An S Corp files Form 1120S with the IRS. This form is used to report the corporation's gross receipts or sales from all sources, cost of goods sold and expenses for running the business. This form is virtually identical to a regular corporate tax return except that the final figure showing ordinary business income or loss is not taxed at this time. There is a major tax advantage to shareholders. If the corporation did not have an S Corp status, it would be taxed on its income at corporate tax rates. Any excess profit paid to shareholders as dividends would be taxed again on each shareholder's tax return. This is double taxation of corporate income.
  
  

Reporting Corporate Income or Loss to Shareholders

• Schedule K is used to consolidate the totals of various corporate transactions that will have a tax effect on Shareholders such as net rental real estate income or loss, dividends that the corporation receives from other corporations and royalties. Capital gains and losses, depreciation and tax credits are among the figures shown on this schedule. Schedule K is just a way for a corporation to report the totals of various tax-related transactions that will impact the individual shareholders. These transactions will be reported to each shareholder based on their percentage of ownership in the corporation.
  
  

How is the S Corporation Profit or Loss Allocated to Individual Shareholders?

• S Corporations can have no more than 100 shareholders to qualify for the S Corp status. The corporation determines how many shares each shareholder owns, and then it divides that number by the total shares outstanding. This calculates the ownership percentage for each shareholder. The corporation uses this percentage of ownership to calculate each shareholder's pro rata share of each tax item on Schedule K. These numbers are transferred to an individual Schedule K-1 for each shareholder. The Schedule K-1 is mailed to all shareholders so that they may report their individual tax transactions on their personal 1040 tax return.
  
  

Finalizing the Reporting of S Corp Profit or Loss

• Each shareholder is required to file a 1040 tax return using the information reported on Schedule K1. If the corporation has a profit, that profit is reported by each shareholder based on his individual participation. The shareholder is taxed at whatever tax rate he ends up at after completing his 1040 tax return. If the corporation reported a loss on its business operation, then that loss can be offset by the shareholder to reduce overall income from other sources on his personal 1040 tax form.