Free Form 1120-S Tax Form

What Is Form 1120-S?

IRS Form 1120-S is the annual federal income tax return filed by S corporations — domestic corporations that have elected pass-through tax treatment under Subchapter S of the Internal Revenue Code by filing Form 2553. The S corporation structure combines the limited liability protection of a corporation with the pass-through taxation of a partnership, allowing business income to be taxed only once at the shareholder level rather than being subject to the double taxation that applies to C corporations (corporate tax plus dividend tax).

Form 1120-S serves as both an information return (like Form 1065 for partnerships) and, in limited circumstances, a tax return. While the S corporation generally does not pay federal income tax on its operating income, it may owe entity-level taxes in specific situations: the built-in gains tax on appreciated assets converted from C corporation status, the excess net passive income tax when the corporation has accumulated earnings and profits from C corporation years and more than 25% of gross receipts are passive investment income, and the LIFO recapture tax when converting from LIFO inventory accounting. These entity-level taxes are calculated and reported on Form 1120-S and paid by the corporation directly.

The form requires reporting of gross income, deductions, tax computation (for entity-level taxes if applicable), shareholder information, balance sheet data, and the allocation of income, deductions, and credits to shareholders via Schedule K and individual Schedule K-1 forms. Unlike partnerships, S corporation income allocations must be strictly proportional to stock ownership — the one-class-of-stock rule prevents the special allocations that partnerships frequently use to distribute income among partners disproportionate to their ownership percentages.

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Reasonable Compensation Requirements

The reasonable compensation doctrine is the most frequently litigated issue in S corporation taxation. When a shareholder-employee performs services for the S corporation, the corporation must pay that individual a reasonable salary before distributing additional profits as non-wage distributions. Wages are subject to FICA taxes (the combined 15.3% employer and employee share of Social Security and Medicare taxes), while distributions from an S corporation are not. This tax rate differential creates a powerful incentive for shareholder-employees to minimize salary and maximize distributions, which the IRS actively monitors and challenges.

Courts and the IRS evaluate reasonable compensation using a multi-factor analysis that considers the nature and extent of services rendered, the employee's qualifications and experience, the time and effort devoted to the business, the compensation paid by comparable businesses for comparable services, the corporation's gross and net income, the distribution history of the corporation, and the salary paid to non-shareholder employees performing similar functions. In Watson v. Commissioner (2012), the Eighth Circuit upheld the recharacterization of $120,000 in distributions as wages for an accountant who paid himself only $24,000 in salary despite the firm earning over $200,000 in net income. The IRS has indicated that paying zero salary to a shareholder-employee who provides more than minor services is virtually always unreasonable.

Shareholder Basis Tracking

Shareholder basis is the cornerstone of S corporation tax planning and compliance. Every shareholder must maintain an annual basis calculation because basis determines three critical tax outcomes: the deductibility of pass-through losses (losses are deductible only to the extent of basis), the tax treatment of distributions (distributions exceeding basis are taxed as capital gains), and the gain or loss recognized on disposition of S corporation stock.

S corporation basis operates under a strict ordering rule established by IRC Section 1367. Beginning with the shareholder's basis from the prior year, the annual calculation proceeds as follows: first, basis increases for the shareholder's pro-rata share of all income items (both separately and non-separately stated), including tax-exempt income; then basis decreases (but not below zero) for distributions; then basis decreases for non-deductible, non-capital expenses; and finally basis decreases for the shareholder's pro-rata share of losses and deductions. This ordering is significant because it allows tax-free distributions to reduce basis before losses, potentially leaving more basis available for loss deductions than if losses were applied first.

How to File Form 1120-S

Frequently Asked Questions

Official Resources

Authoritative IRS resources for S corporation tax filing and compliance.