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Effect of S Corporation Election on Shareholders
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Similar to a partnership, shareholders in an S corporation must include on their personal income tax return their distributive share of each separate "pass-thru" item. Shareholders are taxed on these items, regardless of whether or not the items have been distributed (withdrawn) to them during the year.
Pass-Through of Income and/or Losses (To shareholder / K-1)
Net income (or loss) is passed-through to shareholders as follows:
- Like partnerships, S corporations report both separately and non-separately stated items of income and/or loss. Separately stated income items include dividends, interest, capital gains and losses, Section 1231 gains and losses, etc. Separately stated deductions include charitable contributions, Section 179 expenses, etc.
- Allocations to shareholders are made on a per-share, per-day basis.
- Losses are limited to a shareholder's adjusted basis in S corporation stock plus direct shareholder loans to the corporation. Shareholder guarantees do not increase basis. Any losses disallowed may be carried forward indefinitely and will be deductible as the shareholder's basis is increased.
The following are the most common S corporation items flow through to the shareholder in a manner similar to a partnership:
- Ordinary income (not subject to FICA)
- Rental income/loss
- Portfolio income (including interest, dividends, royalties, and all capital gain (losses))
- Tax-exempt interest
- Percentage depletion
- Foreign income tax
- Section 1231 gains and losses
- Charitable contributions
- Expense deduction for recovery property (Section 179)
Fringe Benefits
Deductible Fringe Benefits
Fringe benefits are deductible for non-shareholder employees and those employee shareholders owning 2% or less of the S corporation.
Non-deductible Fringe Benefits
The cost of fringe benefits for shareholders owning over 2% is not deductible to the S corporation, unless the corporation includes the benefits in the employee/shareholder's W-2 income.
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