2003 HTML Instructions for Form 1120S,

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Table of Contents

General Instructions for Schedules K and K-1. Shareholders' Shares of Income, Credits, Deductions, etc.

Purpose of Schedules

The corporation is liable for taxes on lines 22a, 22b, and 22c, page 1, Form 1120S. Shareholders are liable for income tax on their shares of the corporation's income (reduced by any taxes paid by the corporation on income) and must include their share of the income on their tax return whether or not it is distributed to them. Unlike most partnership income, S corporation income is not self-employment income and is not subject to self-employment tax.

Schedule K is a summary schedule of all shareholders' shares of the corporation's income, deductions, credits, etc. Schedule K-1 shows each shareholder's separate share. Attach a copy of each shareholder's Schedule K-1 to the Form 1120S filed with the IRS. Keep a copy as a part of the corporation's records, and give each shareholder a separate copy.

The total pro rata share items (column (b)) of all Schedules K-1 should equal the amount reported on the same line of Schedule K. Lines 1 through 20 of Schedule K correspond to lines 1 through 20 of Schedule K-1. Other lines do not correspond, but instructions explain the differences.

Be sure to give each shareholder a copy of the Shareholder's Instructions for Schedule K-1 (Form 1120S). These instructions are available separately from Schedule K-1 at most IRS offices.

Note:

Instructions that apply only to line items reported on Schedule K-1 may be prepared and given to each shareholder instead of the instructions printed by the IRS.

Substitute Forms

The corporation does not need IRS approval to use a substitute Schedule K-1 if it is an exact copy of the IRS schedule, or if it contains only those lines the taxpayer is required to use, and the lines have the same numbers and titles and are in the same order as on the IRS Schedule K-1. In either case, the substitute schedule must include the OMB number and either (a) the Shareholder's Instructions for Schedule K-1 (Form 1120S) or (b) instructions that apply to the items reported on Schedule K-1 (Form 1120S).

The corporation must request IRS approval to use other substitute Schedules K-1. To request approval, write to Internal Revenue Service, Attention: Substitute Forms Program Coordinator, SE:W:CAR:MP:T:T:SP, 1111 Constitution Avenue, NW, Washington, DC 20224.

The corporation may be subject to a penalty if it files a substitute Schedule K-1 that does not conform to the specifications of Rev. Proc. 2003-73, 2003-39 I.R.B. 647.

Shareholder's Pro Rata Share Items

General Rule

Items of income, loss, deductions, etc., are allocated to a shareholder on a daily basis, according to the number of shares of stock held by the shareholder on each day during the tax year of the corporation. See the instructions for item A.

A shareholder who disposes of stock is treated as the shareholder for the day of disposition. A shareholder who dies is treated as the shareholder for the day of the shareholder's death.

Special Rules

Termination of shareholder's interest. If a shareholder terminates his or her interest in a corporation during the tax year, the corporation, with the consent of all affected shareholders (including the one whose interest is terminated), may elect to allocate income and expenses, etc., as if the corporation's tax year consisted of 2 separate tax years, the first of which ends on the date of the shareholder's termination.

To make the election, the corporation must attach a statement to a timely filed original or amended Form 1120S for the tax year for which the election is made. In the statement, the corporation must state that it is electing under section 1377(a)(2) and Regulations section 1.1377-1(b) to treat the tax year as if it consisted of 2 separate tax years. The statement must also explain how the shareholder's entire interest was terminated (e.g., sale or gift), and state that the corporation and each affected shareholder consent to the corporation making the election. A single statement may be filed for all terminating elections made for the tax year. If the election is made, write “Section 1377(a)(2) Election Made” at the top of each affected shareholder's Schedule K-1.

For more details on the election, see Temporary Regulations section 1.1377-1T(b).

Qualifying dispositions. If a qualifying disposition takes place during the tax year, the corporation may make an irrevocable election to allocate income and expenses, etc., as if the corporation's tax year consisted of 2 tax years, the first of which ends on the close of the day the qualifying disposition occurs.

A qualifying disposition is:

A disposition by a shareholder of at least 20% of the corporation's outstanding stock in one or more transactions in any 30-day period during the tax year,
A redemption treated as an exchange under section 302(a) or 303(a) of at least 20% of the corporation's outstanding stock in one or more transactions in any 30-day period during the tax year, or
An issuance of stock that equals at least 25% of the previously outstanding stock to one or more new shareholders in any 30-day period during the tax year.

To make the election, the corporation must attach a statement to a timely filed original or amended Form 1120S for the tax year for which the election is made. In the statement, the corporation must state that it is electing under Regulations section 1.1368-1(g)(2)(i) to treat the tax year as if it consisted of separate tax years, give the facts relating to the qualifying disposition (e.g., sale, gift, stock issuance, or redemption), and state that each shareholder who held stock in the corporation during the tax year consents to the election. A single election statement may be filed for all elections made under this special rule for the tax year.

For more details on the election, see Temporary Regulations section 1.1368-1T(g)(2).

Specific Instructions (Schedule K-1 Only)

General Information

On each Schedule K-1, complete the date spaces at the top; enter the names, addresses, and identifying numbers of the shareholder and corporation; complete items A through D; and enter the shareholder's pro rata share of each item. Schedule K-1 must be prepared and given to each shareholder on or before the day on which Form 1120S is filed.

Note:

Space has been provided on line 23 (Supplemental Information) of Schedule K-1 for the corporation to provide additional information to shareholders. This space, if sufficient, should be used in place of any attached schedules required for any lines on Schedule K-1, or other amounts not shown on lines 1 through 22 of Schedule K-1. Please be sure to identify the applicable line number next to the information entered below line 23.

Special Reporting Requirements for Corporations With Multiple Activities

If items of income, loss, deduction, or credit from more than one activity (determined for purposes of the passive activity loss and credit limitations) are reported on lines 1, 2, or 3 of Schedule K-1, the corporation must provide information for each activity to its shareholders. See Passive Activity Reporting Requirements on page 11 for details on the reporting requirements.

Special Reporting Requirements for At-Risk Activities

If the corporation is involved in one or more at-risk activities for which a loss is reported on Schedule K-1, the corporation must report information separately for each at-risk activity. See section 465(c) for a definition of at-risk activities.

For each at-risk activity, the following information must be provided on an attachment to Schedule K-1:

A statement that the information is a breakdown of at-risk activity loss amounts.
The identity of the at-risk activity; the loss amount for the activity; other income and deductions; and other information that relates to the activity.

Specific Items

Item A

If there was no change in shareholders or in the relative interest in stock the shareholders owned during the tax year, enter the percentage of total stock owned by each shareholder during the tax year. For example, if shareholders X and Y each owned 50% for the entire tax year, enter 50% in item A for each shareholder. Each shareholder's pro rata share items (lines 1 through 20 of Schedule K-1) are figured by multiplying the Schedule K amount on the corresponding line of Schedule K by the percentage in item A.

If there was a change in shareholders or in the relative interest in stock the shareholders owned during the tax year, each shareholder's percentage of ownership is weighted for the number of days in the tax year that stock was owned. For example, A and B each held 50% for half the tax year and A, B, and C held 40%, 40%, and 20%, respectively, for the remaining half of the tax year. The percentage of ownership for the year for A, B, and C is figured as follows and is then entered in item A.

Shareholder chart

If there was a change in shareholders or in the relative interest in stock the shareholders owned during the tax year, each shareholder's pro rata share items generally are figured by multiplying the Schedule K amount by the percentage in item A. However, if a shareholder terminated his or her entire interest in the corporation during the year or a qualifying disposition took place, the corporation may elect to allocate income and expenses, etc., as if the tax year consisted of 2 tax years, the first of which ends on the day of the termination or qualifying disposition. See Special Rules on page 19 for more details. Each shareholder's pro rata share items are figured separately for each period on a daily basis, based on the percentage of stock held by the shareholder on each day.

Item C

If the corporation is a registration-required tax shelter or has invested in a registration-required tax shelter, it must enter its tax shelter registration number in item C. Also, a corporation that has invested in a registration-required shelter must furnish a copy of its Form 8271 to its shareholders. See Form 8271 for more details.

Specific Instructions (Schedules K and K-1, Except as Noted)

Income (Loss)

Reminder: Before entering income items on Schedule K or K-1, be sure to reduce the items of income for the following:

Built-in gains tax (Schedule D, Part III, line 22). Each recognized built-in gain item (within the meaning of section 1374(d)(3)) is reduced by its proportionate share of the built-in gains tax.
Excess net passive income tax (line 22a, page 1, Form 1120S). Each item of passive investment income (within the meaning of section 1362(d)(3)(C)) is reduced by its proportionate share of the net passive income tax.

Line 1. Ordinary Income (Loss) From Trade or Business Activities

Enter the amount from line 21, page 1. Enter the income or loss without reference to (a) shareholders' basis in the stock of the corporation and in any indebtedness of the corporation to the shareholders (section 1366(d)), (b) shareholders' at-risk limitations, and (c) shareholders' passive activity limitations. These limitations, if applicable, are determined at the shareholder level.

If the corporation is involved in more than one trade or business activity, see Passive Activity Reporting Requirements on page 11 for details on the information to be reported for each activity. If an at-risk activity loss is reported on line 1, see Special Reporting Requirements for At-Risk Activities above.

Line 2. Net Income (Loss) From Rental Real Estate Activities

Enter the net income or loss from rental real estate activities of the corporation from Form 8825, Rental Real Estate Income and Expenses of a Partnership or an S Corporation. Each Form 8825 has space for reporting the income and expenses of up to eight properties.

If the corporation has income or loss from more than one rental real estate activity reported on line 2, see Passive Activity Reporting Requirements on page 11 for details on the information to be reported for each activity. If an at-risk activity loss is reported on line 2, see Special Reporting Requirements for At-Risk Activities on page 20.

Line 3. Income and Expenses of Other Rental Activities

Enter on lines 3a and 3b of Schedule K (line 3 of Schedule K-1) the income and expenses of rental activities other than those reported on Form 8825. If the corporation has more than one rental activity reported on line 3, see Passive Activity Reporting Requirements on page 11 for details on the information to be reported for each activity. If an at-risk activity loss is reported on line 3, see Special Reporting Requirements for At-Risk Activities on page 20. Also see Rental Activities on page 8 for a definition and other details on other rental activities.

Lines 4a Through 4f. Portfolio Income (Loss)

Enter portfolio income (loss) on lines 4a through 4f. See Portfolio Income on page 9 for the definition of portfolio income. Do not reduce portfolio income by deductions allocated to it. Report such deductions (other than interest expense) on line 9 of Schedules K and K-1. Interest expense allocable to portfolio income is generally investment interest expense and is reported on line 11a of Schedules K and K-1.

Line 4a. Enter only taxable interest on this line from portfolio income. Interest income derived in the ordinary course of the corporation's trade or business, such as interest charged on receivable balances, is reported on line 5, page 1, Form 1120S. See Temporary Regulations section 1.469-2T(c)(3).

Lines 4b(1) and 4b(2). Enter only taxable ordinary dividends on these lines. Enter on line 4b(1) all qualified dividends from line 4b(2). Qualified dividends are dividends received after December 31, 2002, from domestic corporations and qualified foreign corporations.

Qualified dividends. Qualified dividends do not include:

Dividends paid by organizations that are exempt from tax under section 501 or 521 in either the tax year of the distribution or the preceding tax year,
Dividends for which a mutual savings bank received a deduction under section 591,
Deductible dividends paid on employer securities, or
Dividends that relate to payments that the shareholder is obligated to make with respect to short sales or positions in substantially similar or related property.

Qualified foreign corporation. A foreign corporation is a qualified foreign corporation if it is:

Incorporated in a possession of the United States or
Eligible for benefits of a comprehensive income tax treaty with the United States that the Secretary determines is satisfactory for this purpose and that includes an exchange of information program. See Notice 2003-69, 2003-42 I.R.B. 851 for details.

If the foreign corporation does not meet either 1 or 2 above, then it may be treated as a qualified foreign corporation for any dividend paid by the corporation if the stock associated with the dividend paid is readily tradable on an established securities market in the United States.

However, qualified dividends do not include dividends paid by the following foreign entities in either the tax year of the distribution or the preceding tax year:

A foreign investment company (section 1246(b)),
A passive foreign investment company (section 1297), or
A foreign personal holding company (section 552).

See Notice 2003-79 for more details.

Lines 4d(1) and 4d(2). Enter on line 4d(1) the Post-May 5, 2003, gain or loss from line 6a of Schedule D (Form 1120S). Enter on line 4d(2) the gain (loss) for the entire year from line 6b of Schedule D (Form 1120S).

Lines 4e(1) and 4e(2). Enter on line 4e(1) the Post-May 5, 2003, gain or loss that is portfolio income (loss) from Schedule D (Form 1120S), line 13. Enter on line 4e(2) the gain or loss for the entire year that is portfolio income (loss) from Schedule D (Form 1120S), line 14.

If any gain or loss from lines 6, 13, and 14 of Schedule D is not portfolio income (e.g., gain or loss from the disposition of nondepreciable personal property used in a trade or business), do not report this income or loss on lines 4d(1) through 4e(2). Instead, report it on line 6.

Line 4f. Enter any other portfolio income not reported on lines 4a through 4e.

If the corporation holds a residual interest in a REMIC, report on an attachment for line 4f each shareholder's share of taxable income (net loss) from the REMIC (line 1b of Schedule Q (Form 1066)); excess inclusion (line 2c of Schedule Q (Form 1066)); and section 212 expenses (line 3b of Schedule Q (Form 1066)). Because Schedule Q (Form 1066) is a quarterly statement, the corporation must follow the Schedule Q (Form 1066) Instructions for Residual Interest Holder to figure the amounts to report to shareholders for the corporation's tax year.

Line 5. Net Section 1231 Gain (Loss) (Except From Casualty or Theft)

Enter on line 5a the Post-May 5, 2003, net section 1231 gain (loss) from Form 4797, line 7, column (h). Enter on line 5b the net section 1231 gain (loss) for the entire year from Form 4797, line 7, column (g). If the corporation had a gain prior to May 6, 2003, from any section 1231 property held more than 5 years, show the total of all such gains on an attachment to Schedule K-1 (do not include any gain attributable to straight-line depreciation from section 1250 property). Indicate on the statement that this amount should be included in the shareholder's computation of qualified 5-year gain only if the amount on the shareholder's Form 4797, line 7, is more than zero.

Do not include gain or loss from involuntary conversions due to casualty or theft on lines 5a or 5b. Report net gain or loss from involuntary conversions due to casualty or theft on line 6.

If the corporation is involved in more than one trade or business or rental activity, see Passive Activity Reporting Requirements on page 11 for details on the information to be reported for each activity. If an at-risk activity loss is reported on line 5, see Special Reporting Requirements for At-Risk Activities on page 20.

Line 6. Other Income (Loss)

Enter any other item of income or loss not included on lines 1 through 5. Items to be reported on line 6 include:

Recoveries of tax benefit items (section 111).
Gambling gains and losses (section 165(d)).
Gains from the disposition of an interest in oil, gas, geothermal, or other mineral properties (section 1254).
Net gain (loss) from involuntary conversions due to casualty or theft. The amount for this item is shown on Form 4684, Casualties and Thefts, line 38a or 38b.
Any net gain or loss from section 1256 contracts from Form 6781, Gains and Losses From Section 1256 Contracts and Straddles.
Gain from the sale or exchange of qualified small business stock (as defined in the Instructions for Schedule D) that is eligible for the 50% section 1202 exclusion. To be eligible for the section 1202 exclusion, the stock must have been held by the corporation for more than 5 years. Corporate shareholders are not eligible for the section 1202 exclusion. Additional limitations apply at the shareholder level. Report each shareholder's share of section 1202 gain on Schedule K-1. Each shareholder will determine if he or she qualifies for the section 1202 exclusion. Report on an attachment to Schedule K-1 for each sale or exchange the name of the qualified small business that issued the stock, the shareholder's share of the corporation's adjusted basis and sales price of the stock, and the dates the stock was bought and sold.
Gain eligible for section 1045 rollover (replacement stock purchased by the corporation). Include only gain from the sale or exchange of qualified small business stock (as defined in the Instructions for Schedule D) that was deferred by the corporation under section 1045 and reported on Schedule D. See the Instructions for Schedule D for more details. Corporate shareholders are not eligible for the section 1045 rollover. Additional limitations apply at the shareholder level. Report each shareholder's share of the gain eligible for section 1045 rollover on Schedule K-1. Each shareholder will determine if he or she qualifies for the rollover. Report on an attachment to Schedule K-1 for each sale or exchange the name of the qualified small business that issued the stock, the shareholder's share of the corporation's adjusted basis and sales price of the stock, and the dates the stock was bought and sold.
Gain eligible for section 1045 rollover (replacement stock not purchased by the corporation). Include only gain from the sale or exchange of qualified small business stock (as defined in the Instructions for Schedule D) the corporation held for more than 6 months but that was not deferred by the corporation under section 1045. See the Instructions for Schedule D for more details. A shareholder (other than a corporation) may be eligible to defer his or her pro rata share of this gain under section 1045 if he or she purchases other qualified small business stock during the 60-day period that began on the date the stock was sold by the corporation. Additional limitations apply at the shareholder level. Report on an attachment to Schedule K-1 for each sale or exchange the name of the qualified small business that issued the stock, the shareholder's share of the corporation's adjusted basis and sales price of the stock, and the dates the stock was bought and sold.
If the corporation had a gain before May 6, 2003, from the disposition of non-depreciable personal property used in a trade or business held more than 5 years, show the total of all such gains on an attachment to Schedule K-1. Indicate on the statement that the shareholder should include this amount on line 5 of the worksheet for line 35 of Schedule D (Form 1040). If the income or loss is attributable to more than one activity, report the income or loss amount separately for each activity on an attachment to Schedule K-1 and identify the activity to which the income or loss relates.

If the corporation is involved in more than one trade or business or rental activity, see Passive Activity Reporting Requirements on page 11 for details on the information to be reported for each activity. If an at-risk activity loss is reported on line 6, see Special Reporting Requirements for At-Risk Activities on page 20.

Deductions

Line 7. Charitable Contributions

Enter the amount of charitable contributions paid during the tax year. On an attachment to Schedules K and K-1, show separately the dollar amount of contributions subject to each of the 50%, 30%, and 20% of adjusted gross income limits. For additional information, see Pub. 526, Charitable Contributions.

An accrual basis S corporation may not elect to treat a contribution as having been paid in the tax year the board of directors authorizes the payment if the contribution is not actually paid until the next tax year.

Generally, no deduction is allowed for any contribution of $250 or more unless the corporation obtains a written acknowledgment from the charitable organization that shows the amount of cash contributed, describes any property contributed, and gives an estimate of the value of any goods or services provided in return for the contribution. The acknowledgment must be obtained by the due date (including extensions) of the corporation's return, or if earlier, the date the corporation files its return. Do not attach the acknowledgment to the tax return, but keep it with the corporation's records. These rules apply in addition to the filing requirements for Form 8283 described below.

Certain contributions made to an organization conducting lobbying activities are not deductible. See section 170(f)(9) for more details.

If the deduction claimed for noncash contributions exceeds $500, complete Form 8283, Noncash Charitable Contributions, and attach it to Form 1120S. The corporation must give a copy of its Form 8283 to every shareholder if the deduction for any item or group of similar items of contributed property exceeds $5,000, even if the amount allocated to any shareholder is $5,000 or less.

If the deduction for an item or group of similar items of contributed property is $5,000 or less, the corporation must report each shareholder's pro rata share of the amount of noncash contributions to enable individual shareholders to complete their own Forms 8283. See the Instructions for Form 8283 for more information.

If the corporation made a qualified conservation contribution under section 170(h), also include the fair market value of the underlying property before and after the donation, as well as the type of legal interest contributed, and describe the conservation purpose furthered by the donation. Give a copy of this information to each shareholder.

Line 8. Section 179 Expense Deduction

An S corporation may elect to expense part of the cost of certain property that the corporation purchased during the tax year for use in its trade or business or certain rental activities. See the Instructions for Form 4562 for more information.

Complete Part I of Form 4562 to figure the corporation's section 179 expense deduction. The corporation does not claim the deduction itself, but instead passes it through to the shareholders. Attach Form 4562 to Form 1120S and show the total section 179 expense deduction on Schedule K, line 8. Report each individual shareholder's pro rata share on Schedule K-1, line 8. Do not complete line 8 of Schedule K-1 for any shareholder that is an estate or trust.

If the corporation is an enterprise zone business, also report on an attachment to Schedules K and K-1 the cost of section 179 property placed in service during the year that is qualified zone property.

See the instructions for line 23 of Schedule K-1, item 3, for sales or other dispositions of property for which a section 179 expense deduction has passed through to shareholders. See item 4 for recapture if the business use of the property dropped to 50% or less.

Line 9. Deductions Related to Portfolio Income (Loss)

Enter on line 9 the deductions clearly and directly allocable to portfolio income (other than interest expense). Interest expense related to portfolio income is investment interest expense and is reported on line 11a of Schedules K and K-1. Generally, the line 9 expenses are section 212 expenses and are subject to section 212 limitations at the shareholder level.

Note:

No deduction is allowed under section 212 for expenses allocable to a convention, seminar, or similar meeting. Because these expenses are not deductible by shareholders, the corporation does not report these expenses on line 9 or line 10. The expenses are nondeductible and are reported as such on line 19 of Schedules K and K-1.

Line 10. Other Deductions

Enter any other deductions not included on lines 7, 8, 9, and 15g. On an attachment, identify the deduction and amount, and if the corporation has more than one activity, the activity to which the deduction relates.

Examples of items to be reported on an attachment to line 10 include:

Amounts (other than investment interest required to be reported on line 11a of Schedules K and K-1) paid by the corporation that would be allowed as itemized deductions on a shareholder's income tax return if they were paid directly by a shareholder for the same purpose. These amounts include, but are not limited to, expenses under section 212 for the production of income other than from the corporation's trade or business.
Any penalty on early withdrawal of savings not reported on line 9 because the corporation withdrew funds from its time savings deposit before its maturity.
Soil and water conservation expenditures (section 175).
Expenditures paid or incurred for the removal of architectural and transportation barriers to the elderly and disabled that the corporation has elected to treat as a current expense. See section 190.
Contributions to a capital construction fund.
Interest expense allocated to debt-financed distributions. See Notice 89-35, 1989-1 C.B. 675, for more information.
If there was a gain (loss) from a casualty or theft to property not used in a trade or business or for income-producing purposes, provide each shareholder with the needed information to complete Form 4684.

Investment Interest

Complete lines 11a and 11b for all shareholders.

Line 11a. Investment Interest Expense

Include on this line the interest properly allocable to debt on property held for investment purposes. Property held for investment includes property that produces income (unless derived in the ordinary course of a trade or business) from interest, dividends, annuities, or royalties; and gains from the disposition of property that produces those types of income or is held for investment.

Investment interest expense does not include interest expense allocable to a passive activity.

Report investment interest expense only on line 11a of Schedules K and K-1.

The amount on line 11a will be deducted by individual shareholders on Schedule A (Form 1040), line 13, after applying the investment interest expense limitations of section 163(d).

For more information, see Form 4952, Investment Interest Expense Deduction.

Lines 11b(1) and 11b(2). Investment Income and Expenses

Enter on line 11b(1) only the investment income included on lines 4a, b(2), c, and f of Schedule K-1. Do not include other portfolio gains or losses on this line.

Enter on line 11b(2) only the investment expense included on line 9 of Schedule K-1.

If there are other items of investment income or expense included in the amounts that are required to be passed through separately to the shareholders on Schedule K-1, such as net short-term capital gain or loss, net long-term capital gain or loss, and other portfolio gains or losses, give each shareholder a schedule identifying these amounts.

Investment income includes gross income from property held for investment, the excess of net gain attributable to the disposition of property held for investment over net capital gain from the disposition of property held for investment, and any net capital gain from the disposition of property held for investment that each shareholder elects to include in investment income under section 163(d)(4)(B)(iii). Generally, investment income and investment expenses do not include any income or expenses from a passive activity. See Regulations section 1.469-2(f)(10) for exceptions.

Property subject to a net lease is not treated as investment property because it is subject to the passive loss rules. Do not reduce investment income by losses from passive activities.

Investment expenses are deductible expenses (other than interest) directly connected with the production of investment income. See the Instructions for Form 4952 for more information on investment income and expenses.

Credits

Note:

If the corporation has credits from more than one trade or business activity on line 12a or 13, or from more than one rental activity on line 12b, 12c, 12d, or 12e, it must report separately on an attachment to Schedule K-1, the amount of each credit and provide any other applicable activity information listed in Passive Activity Reporting Requirements on page 11. However, do not attach Form 3800, General Business Credit, to Form 1120S.

Line 12a. Credit for Alcohol Used as Fuel

Enter on line 12a of Schedule K the credit for alcohol used as fuel attributable to trade or business activities. Enter on line 12d or 12e the credit for alcohol used as fuel attributable to rental activities. Figure the credit on Form 6478, Credit for Alcohol Used as Fuel, and attach it to Form 1120S. The credit must be included in income on page 1, line 5, of Form 1120S. See section 40(f) for an election the corporation can make to have the credit not apply.

Enter each shareholder's share of the credit for alcohol used as fuel on line 12a, 12d, or 12e of Schedule K-1.

If this credit includes the small ethanol producer credit, identify on a statement attached to each Schedule K-1 (a) the amount of the small producer credit included in the total credit allocated to the shareholder, (b) the number of gallons of qualified ethanol fuel production allocated to the shareholder, and (c) the shareholder's pro rata share, in gallons, of the corporation's productive capacity for alcohol.

Line 12b. Low-Income Housing Credit

Section 42 provides for a credit that may be claimed by owners of low-income residential rental buildings. If shareholders are eligible to claim the low-income housing credit, complete the applicable parts of Form 8586, Low-Income Housing Credit, and attach it to Form 1120S. Enter the credit figured by the corporation on Form 8586, and any low-income housing credit received from other entities in which the corporation is allowed to invest, on the applicable line as explained below. The corporation must also complete and attach Form 8609, Low-Income Housing Credit Allocation Certification, and Schedule A (Form 8609), Annual Statement, to Form 1120S. See the Instructions for Form 8586 and Form 8609 for information on completing these forms.

Line 12b(1). If the corporation invested in a partnership to which the provisions of section 42(j)(5) apply, report on line 12b(1) the credit the partnership reported to the corporation on line 12a(1) of Schedule K-1 (Form 1065).

Line 12b(2). Report on line 12b(2) any low-income housing credit not reported on line 12b(1). This includes any credit from a partnership reported to the corporation on line 12a(2) of Schedule K-1 (Form 1065).

Note:

If part or all of the credit reported on line 12b(1) or 12b(2) is attributable to additions to qualified basis of property placed in service before 1990, report on an attachment to Schedules K and K-1 the amount of the credit on each line that is attributable to property placed in service (a) before 1990 and (b) after 1989.

Line 12c. Qualified Rehabilitation Expenditures Related to Rental Real Estate Activities

Enter total qualified rehabilitation expenditures related to rental real estate activities of the corporation. For line 12c of Schedule K, complete the applicable lines of Form 3468, Investment Credit, that apply to qualified rehabilitation expenditures for property related to rental real estate activities of the corporation for which income or loss is reported on line 2 of Schedule K. See Form 3468 for details on qualified rehabilitation expenditures. Attach Form 3468 to Form 1120S.

For line 12c of Schedule K-1, enter each shareholder's pro rata share of the expenditures. On the dotted line to the left of the entry space for line 12c, enter the line number of Form 3468 on which the shareholder should report the expenditures. If there is more than one type of expenditure, or the expenditures are from more than one line 2 activity, report this information separately for each expenditure or activity on an attachment to Schedules K and K-1.

Note:

Qualified rehabilitation expenditures not related to rental real estate activities must be listed separately on line 23 of Schedule K-1.

Line 12d. Credits (Other Than Credits Shown on Lines 12b and 12c) Related to Rental Real Estate Activities

Enter on line 12d any other credit (other than credits on lines 12b and 12c) related to rental real estate activities. On the dotted line to the left of the entry space for line 12d, identify the type of credit. If there is more than one type of credit or the credit is from more than one line 2 activity, report this information separately for each credit or activity on an attachment to Schedules K and K-1. These credits may include any type of credit listed in the instructions for line 13.

Line 12e. Credits Related to Other Rental Activities

Enter on line 12e any credit related to other rental activities for which income or loss is reported on line 3 of Schedules K and K-1. On the dotted line to the left of the entry space for line 12e, identify the type of credit. If there is more than one type of credit or the credit is from more than one line 3 activity, report this information separately for each credit or activity on an attachment to Schedules K and K-1. These credits may include any type of credit listed in the instructions for line 13.

Line 13. Other Credits

Enter on line 13 any other credit, except credits or expenditures shown or listed for lines 12a through 12e of Schedules K and K-1 or the credit for Federal tax paid on fuels (which is reported on line 23c of page 1). On the dotted line to the left of the entry space for line 13, identify the type of credit. If there is more than one type of credit or the credit is from more than one activity, report this information separately for each credit or activity on an attachment to Schedules K and K-1.

The credits to be reported on line 13 and other required attachments follow.

Credit for backup withholding on dividends, interest, or patronage dividends.
Nonconventional source fuel credit. Figure this credit on a separate schedule and attach it to Form 1120S. See section 29 for rules on figuring the credit.
Qualified electric vehicle credit (Form 8834).
Unused investment credit from cooperatives. If the corporation is a member of a cooperative that passes an unused investment credit through to its members, the credit is in turn passed through to the corporation's shareholders.
Work opportunity credit (Form 5884).
Welfare-to-work credit (Form 8861).
Credit for increasing research activities (Form 6765).
Enhanced oil recovery credit (Form 8830).
Disabled access credit (Form 8826).
Renewable electricity production credit (Form 8835).
Empowerment zone and renewable community employment credit (Form 8844).
Indian employment credit (Form 8845).
Credit for employer social security and Medicare taxes paid on certain employee tips (Form 8846).
Orphan drug credit (Form 8820).
New markets credit (Form 8874).
Credit for contributions to selected community development corporations (Form 8847).
Credit for small employer pension start-up costs (Form 8881).
Credit for employer-provided child care facilities and services (Form 8882).
New York Liberty Zone business employee credit (Form 8884).
Qualified zone academy bond credit (Form 8860).
General credits from an electing large partnership.

See the instructions for line 21 (Schedule K) and line 23 (Schedule K-1) to report expenditures qualifying for the (a) rehabilitation credit not related to rental real estate activities, (b) energy credit, or (c) reforestation credit.

Adjustments and Tax Preference Items

Lines 14a through 14e must be completed for all shareholders.

Enter items of income and deductions that are adjustments or tax preference items for the alternative minimum tax (AMT). See Form 6251, Alternative Minimum Tax—Individuals, or Schedule I of Form 1041, U.S. Income Tax Return for Estates and Trusts, to determine the amounts to enter and for other information.

Do not include as a tax preference item any qualified expenditures to which an election under section 59(e) may apply. Because these expenditures are subject to an election by each shareholder, the corporation cannot figure the amount of any tax preference related to them. Instead, the corporation must pass through to each shareholder on lines 16a and 16b of Schedule K-1 the information needed to figure the deduction.

Line 14a. Depreciation Adjustment on Property Placed in Service After 1986

Figure the adjustment for line 14a based only on tangible property placed in service after 1986 (and tangible property placed in service after July 31, 1986, and before 1987 for which the corporation elected to use the general depreciation system). Do not make an adjustment for motion picture films, videotapes, sound recordings, certain public utility property (as defined in section 168(f)(2)), property depreciated under the unit-of-production method (or any other method not expressed in a term of years), qualified Indian reservation property, property eligible for a special depreciation allowance, qualified revitalization expenditures, or the section 179 expense deduction.

For property placed in service before 1999, refigure depreciation for the AMT as follows (using the same convention used for the regular tax):

For section 1250 property (generally, residential rental and nonresidential real property), use the straight line method over 40 years.
For tangible property (other than section 1250 property) depreciated using the straight line method for the regular tax, use the straight line method over the property's class life. Use 12 years if the property has no class life.
For any other tangible property, use the 150% declining balance method, switching to the straight line method the first tax year it gives a larger deduction, over the property's AMT class life. Use 12 years if the property has no class life.

Note:

See Pub. 946 for a table of class lives.

For property placed in service after 1998, refigure depreciation for the AMT only for property depreciated for the regular tax using the 200% declining balance method. For the AMT, use the 150% declining balance method, switching to the straight line method the first tax year it gives a larger deduction, and the same convention and recovery period used for the regular tax.

Figure the adjustment by subtracting the AMT deduction for depreciation from the regular tax deduction and enter the result on line 14a. If the AMT deduction is more than the regular tax deduction, enter the difference as a negative amount. Depreciation capitalized to inventory must also be refigured using the AMT rules. Include on this line the current year adjustment to income, if any, resulting from the difference.

Line 14b. Adjusted Gain or Loss

If the corporation disposed of any tangible property placed in service after 1986 (or after July 31, 1986, if an election was made to use the General Depreciation System), or if it disposed of a certified pollution control facility placed in service after 1986, refigure the gain or loss from the disposition using the adjusted basis for the AMT. The property's adjusted basis for the AMT is its cost or other basis minus all depreciation or amortization deductions allowed or allowable for the AMT during the current tax year and previous tax years. Enter on this line the difference between the regular tax gain (loss) and the AMT gain (loss). If the AMT gain is less than the regular tax gain, or the AMT loss is more than the regular tax loss, or there is an AMT loss and a regular tax gain, enter the difference as a negative amount.

If any part of the adjustment is allocable to net short-term capital gain (loss), net long-term capital gain (loss), or net section 1231 gain (loss), attach a schedule that identifies the amount of the adjustment allocable to each type of gain or loss. For a net long-term capital gain (loss), also identify the amount of the adjustment that is 28% rate gain (loss). For a net section 1231 gain (loss), also identify the amount of adjustment that is unrecaptured section 1250 gain. Also indicate the amount of any qualified 5-year gain and the portion of each amount that is post-May 5, 2003, gain or loss.

Line 14c. Depletion (Other Than Oil and Gas)

Do not include any depletion on oil and gas wells. The shareholders must figure their depletion deductions and preference items separately under section 613A.

Refigure the depletion deduction under section 611 for mines, wells (other than oil and gas wells), and other natural deposits for the AMT. Percentage depletion is limited to 50% of the taxable income from the property as figured under section 613(a), using only income and deductions for the AMT. Also, the deduction is limited to the property's adjusted basis at the end of the year, as refigured for the AMT. Figure this limit separately for each property. When refiguring the property's adjusted basis, take into account any AMT adjustments made this year or in previous years that affect basis (other than the current year's depletion).

Enter the difference between the regular tax and AMT deduction. If the AMT deduction is greater, enter the difference as a negative amount.

Lines 14d(1) and 14d(2)

Generally, the amounts to be entered on these lines are only the income and deductions for oil, gas, and geothermal properties that are used to figure the amount on line 21, page 1, Form 1120S.

If there are any items of income or deductions for oil, gas, and geothermal properties included in the amounts that are required to be passed through separately to the shareholders on Schedule K-1, give each shareholder a schedule that shows, for the line on which the income or deduction is included, the amount of income or deductions included in the total amount for that line. Do not include any of these direct pass-through amounts on line 14d(1) or 14d(2). The shareholder is told in the Shareholder's Instructions for Schedule K-1 (Form 1120S) to adjust the amounts on lines 14d(1) and 14d(2) for any other income or deductions from oil, gas, or geothermal properties included on lines 2 through 10 and 23 of Schedule K-1 in order to determine the total income and deductions from oil, gas, and geothermal properties for the corporation.

Figure the amounts for lines 14d(1) and 14d(2) separately for oil and gas properties that are not geothermal deposits and for all properties that are geothermal deposits.

Give the shareholders a schedule that shows the separate amounts included in the computation of the amounts on lines 14d(1) and 14d(2).

Line 14d(1). Gross income from oil, gas, and geothermal properties. Enter the total amount of gross income (within the meaning of section 613(a)) from all oil, gas, and geothermal properties received or accrued during the tax year and included on page 1, Form 1120S.

Line 14d(2). Deductions allocable to oil, gas, and geothermal properties. Enter the amount of any deductions allowed for the AMT that are allocable to oil, gas, and geothermal properties.

Line 14e. Other Adjustments and Tax Preference Items

Attach a schedule that shows each shareholder's share of other items not shown on lines 14a through 14d(2) that are adjustments or tax preference items or that the shareholder needs to complete Form 6251 or Schedule I of Form 1041. See these forms and their instructions to determine the amount to enter.

Other adjustments or tax preference items include the following:

Accelerated depreciation of real property under pre-1987 rules.
Accelerated depreciation of leased personal property under pre-1987 rules.
Long-term contracts entered into after February 28, 1986. Except for certain home construction contracts, the taxable income from these contracts must be figured using the percentage of completion method of accounting for the AMT.
Losses from tax shelter farm activities. No loss from any tax shelter farm activity is allowed for the AMT.

Foreign Taxes

Lines 15a through 15h must be completed if the corporation has foreign income, deductions, or losses, or has paid or accrued foreign taxes. See Pub. 514, Foreign Tax Credit for Individuals, for more information.

Line 15a. Name of Foreign Country or U.S. Possession

Enter the name of the foreign country or U.S. possession from which the corporation had income or to which the corporation paid or accrued taxes. If the corporation had income from, or paid or accrued taxes to, more than one foreign country or U.S. possession, enter “See attached” and attach a schedule for each country for lines 15a through 15h.

Line 15b. Gross Income From All Sources

Enter the corporation's gross income from all sources, (both U.S. and foreign).

Line 15c. Gross Income Sourced at Shareholder Level

Enter the total gross income of the corporation that is required to be sourced at the shareholder level. This includes income from the sale of most personal property other than inventory, depreciable property, and certain intangible property. See Pub. 514 and section 865 for details. Attach a schedule showing the following information:

The amount of this gross income (without regard to its source) in each category identified in the instructions for line 15d, including each of the listed categories.
Specifically identify gains on the sale of personal property other than inventory, depreciable property, and certain intangible property on which a foreign tax of 10% or more was paid or accrued. Also list losses on the sale of such property if the foreign country would have imposed a 10% or higher tax had the sale resulted in a gain. See Sales or Exchanges of Certain Personal Property in Pub. 514 and section 865.
Specify foreign source capital gains or losses within each separate limitation category. Also separately identify foreign source gains or losses within each separate limitation category that are 28% rate gains and losses, unrecaptured section 1250 gains, and qualified 5-year gains and indicate the post-May 5, 2003, portion of each.

Line 15d. Foreign Gross Income Sourced at Corporate Level

Separately report gross income from sources outside the United States by category of income as follows. See Pub. 514 for information on the categories of income.

Line 15d(1). Passive foreign source income.

Line 15d(2). Attach a schedule showing the amount of foreign source income included in each of the following listed categories of income:

Financial services income;
High withholding tax interest;
Shipping income;
Dividends from each noncontrolled section 902 corporation;
Dividends from a domestic international sales corporation (DISC) or a former DISC;
Distributions from a foreign sales corporation (FSC) or a former FSC;
Section 901(j) income; and
Certain income re-sourced by treaty.

Line 15d(3). General limitation foreign source income (all other foreign source income).

Line 15e. Deductions Allocated and Apportioned at Shareholder Level

Enter on line 15e(1) the corporation's total interest expense (including interest equivalents under Temporary Regulations section 1.861-9T(b)). Do not include interest directly allocable under Temporary Regulations section 1.861-10T to income from a specific property. This type of interest is allocated and apportioned at the corporate level and is included on lines 15f(1) through (3). On line 15e(2), enter the total of all other deductions or losses that are required to be allocated at the shareholder level. For example, include on line 15e(2) research and experimental expenditures (see Regulations section 1.861-17(f)).

Line 15f. Deductions Allocated and Apportioned at Corporate Level to Foreign Source Income

Separately report corporate deductions that are apportioned at the corporate level to (1) passive foreign source income, (2) each of the listed foreign categories of income, and (3) general limitation foreign source income (see the instructions for line 15d). See Pub. 514 for more information.

Line 15g. Total Foreign Taxes

Enter in U.S. dollars the total foreign taxes (described in section 901 or section 903) that were paid or accrued by the corporation (according to its method of accounting for such taxes). Translate these amounts into U.S. dollars by using the applicable exchange rate (see Pub. 514).

Attach a schedule reporting the following information:

The total amount of foreign taxes (including foreign taxes on income sourced at the shareholder level) relating to each category of income (see instructions for line 15d).
The dates on which the taxes were paid or accrued, the exchange rates used, and the amounts in both foreign currency and U.S. dollars, for:
- Taxes withheld at source on interest.
- Taxes withheld at source on dividends.
- Taxes withheld at source on rents and royalties.
- Other foreign taxes paid or accrued.

Line 15h. Reduction in Taxes Available for Credit

Enter the total reductions in taxes available for credit. Attach a schedule showing the reductions for:

Taxes on foreign mineral income (section 901(e)).
Taxes on foreign oil and gas extraction income (section 907(a)).
Taxes attributable to boycott operations (section 908).
Failure to timely file (or furnish all of the information required on) Forms 5471 and 8865.
Any other items (specify).

Other

Lines 16a and 16b. Section 59(e)(2) Expenditures

Generally, section 59(e) allows each shareholder to make an election to deduct the shareholder's pro rata share of the corporation's otherwise deductible qualified expenditures ratably over 10 years (3 years for circulation expenditures), beginning with the tax year in which the expenditures were made (or for intangible drilling and development costs, over the 60-month period beginning with the month in which such costs were paid or incurred). The term “qualified expenditures” includes only the following types of expenditures paid or incurred during the tax year:

Circulation expenditures.
Research and experimental expenditures.
Intangible drilling and development costs.
Mining exploration and development costs.

If a shareholder makes the election, the above items are not treated as tax preference items.

Because the shareholders are generally allowed to make this election, the corporation cannot deduct these amounts or include them as adjustments or tax preference items on Schedule K-1. Instead, on lines 16a and 16b of Schedule K-1, the corporation passes through the information the shareholders need to figure their separate deductions.

On line 16a, enter the type of expenditures claimed on line 16b. Enter on line 16b the qualified expenditures paid or incurred during the tax year to which an election under section 59(e) may apply. Enter this amount for all shareholders whether or not any shareholder makes an election under section 59(e). If the expenditures are for intangible drilling and development costs, enter the month in which the expenditures were paid or incurred (after the type of expenditures on line 16a). If there is more than one type of expenditure included in the total shown on line 16b (or intangible drilling and development costs were paid or incurred for more than 1 month), report this information separately for each type of expenditure (or month) on an attachment to Schedules K and K-1.

Line 17. Tax-Exempt Interest Income

Enter on line 17 tax-exempt interest income, including any exempt-interest dividends received from a mutual fund or other regulated investment company. This information must be reported by individuals on line 8b of Form 1040. Generally, the basis of the shareholder's stock is increased by the amount shown on this line under section 1367(a)(1)(A).

Line 18. Other Tax-Exempt Income

Enter on line 18 all income of the corporation exempt from tax other than tax-exempt interest (e.g., life insurance proceeds). Generally, the basis of the shareholder's stock is increased by the amount shown on this line under section 1367(a)(1)(A).

Line 19. Nondeductible Expenses

Enter on line 19 nondeductible expenses paid or incurred by the corporation. Do not include separately stated deductions shown elsewhere on Schedules K and K-1, capital expenditures, or items for which the deduction is deferred to a later tax year. Generally, the basis of the shareholder's stock is decreased by the amount shown on this line under section 1367(a)(2)(D).

Line 20

Enter total distributions made to each shareholder other than dividends reported on line 22 of Schedule K. Noncash distributions of appreciated property are valued at fair market value. See Distributions on page 29 for the ordering rules on distributions.

Line 21 (Schedule K Only)

Attach a statement to Schedule K to report the corporation's total income, expenditures, or other information for items 1 through 24 of the line 23 (Schedule K-1 Only) instruction on page 27.

Line 22 (Schedule K Only)

Enter total dividends paid to shareholders from accumulated earnings and profits. Report these dividends to shareholders on Form 1099-DIV. Do not report them on Schedule K-1.

Lines 22a and 22b (Schedule K-1 Only). Recapture of Low-Income Housing Credit

If recapture of part or all of the low-income housing credit is required because (a) prior year qualified basis of a building decreased or (b) the corporation disposed of a building or part of its interest in a building, see Form 8611, Recapture of Low-Income Housing Credit. The instructions for Form 8611 indicate when Form 8611 is completed by the corporation and what information is provided to shareholders when recapture is required.

Note:

If a shareholder's ownership interest in a building decreased because of a transaction at the shareholder level, the corporation must provide the necessary information to the shareholder to enable the shareholder to figure the recapture.

If the corporation filed Form 8693, Low-Income Housing Credit Disposition Bond, to avoid recapture of the low-income housing credit, no entry should be made on line 22 of Schedule K-1.

See Form 8586, Form 8611, and section 42 for more information.

Supplemental Information

Line 23 (Schedule K-1 Only)

Enter in the line 23 Supplemental Information space of Schedule K-1, or on an attached schedule if more space is needed, each shareholder's share of any information asked for on lines 1 through 27 that is required to be reported in detail, and items 1 through 28 below. Please identify the applicable line number next to the information entered in the Supplemental Information space. Show income or gains as a positive number. Show losses in parentheses.

Taxes paid on undistributed capital gains by a regulated investment company or a real estate investment trust (REIT). As a shareholder of a regulated investment company or a REIT, the corporation will receive notice on Form 2439, Notice to Shareholder of Undistributed Long-Term Capital Gains, of the amount of tax paid on undistributed capital gains.
Gross income and other information relating to oil and gas well properties that are reported to shareholders to allow them to figure the depletion deduction for oil and gas well properties. See section 613A(c)(11) for details.

The corporation cannot deduct depletion on oil and gas wells. Each shareholder must determine the allowable amount to report on his or her return. See Pub. 535 for more information.
Gain or loss on the sale, exchange, or other disposition of property for which a section 179 expense deduction has been passed through to shareholders. The corporation must provide all the following information with respect to a disposition of property for which a section 179 expense deduction was passed through to shareholders (see the instructions for line 4 on page 13).
1. Description of the property.
2. Date the property was acquired.
3. Date of the sale or other disposition of the property.
4. The shareholder's pro rata share of the gross sales price.
5. The shareholder's pro rata share of the cost or other basis plus expense of sale (reduced as explained in the instructions for Form 4797, line 21).
6. The shareholder's pro rata share of the depreciation allowed or allowable, determined as described in the instructions for Form 4797, line 22, but excluding the section 179 expense deduction.
7. The shareholder's pro rata share of the section 179 expense deduction (if any) passed through for the property and the corporation's tax year(s) in which the amount was passed through.
8. An indication if the disposition is from a casualty or theft.
9. For an installment sale made during the corporation's tax year, any information needed to complete Form 6252, Installment Sale Income. The corporation also must separately report the shareholder's pro rata share of all payments received for the property in future tax years. (Installment payments received for installment sales made in prior tax years should be reported in the same manner used in prior tax years.)
Recapture of section 179 expense deduction if business use of the property dropped to 50% or less. If the business use of any property (placed in service after 1986) for which a section 179 expense deduction was passed through to shareholders dropped to 50% or less (for a reason other than disposition), the corporation must provide all the following information.
1. The shareholder's pro rata share of the original basis and depreciation allowed or allowable (not including the section 179 expense deduction).
2. The shareholder's pro rata share of the section 179 expense deduction (if any) passed through for the property and the corporation's tax year(s) in which the amount was passed through.
Recapture of certain mining exploration expenditures (section 617).
Any information or statements the corporation is required to furnish to shareholders to allow them to comply with requirements under section 6111 (registration of tax shelters) or section 6662(d)(2)(B)(ii) (regarding adequate disclosure of items that may cause an understatement of income tax).
If the corporation is involved in farming or fishing activities, report the gross income from these activities to shareholders.
Any information needed by a shareholder to compute the interest due under section 453(l)(3). If the corporation elected to report the dispositions of certain timeshares and residential lots on the installment method, each shareholder's tax liability must be increased by the shareholder's pro rata share of the interest on tax attributable to the installment payments received during the tax year.
Any information needed by a shareholder to compute the interest due under section 453A(c). If an obligation arising from the disposition of property to which section 453A applies is outstanding at the close of the year, each shareholder's tax liability must be increased by the tax due under section 453A(c) on the shareholder's pro rata share of the tax deferred under the installment method.
Any information needed by a shareholder to properly capitalize interest as required by section 263A(f). See Section 263A uniform capitalization rules on page 13 for more information.
If the corporation is a closely held S corporation (defined in section 460(b)) and it entered into any long-term contracts after February 28, 1986, that are accounted for under either the percentage of completion-capitalized cost method or the percentage of completion method, it must attach a schedule to Form 1120S showing the information required in items (a) and (b) of the instructions for lines 1 and 3 of Part II for Form 8697, Interest Computation Under the Look-Back Method for Completed Long-Term Contracts. It must also report the amounts for Part II, lines 1 and 3, to its shareholders. See the Instructions for Form 8697 for more information.
Expenditures qualifying for the (a) rehabilitation credit not related to rental real estate activities, (b) energy credit, or (c) reforestation credit. Complete and attach Form 3468 to Form 1120S. See Form 3468 and related instructions for information on eligible property and the lines on Form 3468 to complete. Do not include that part of the cost of the property the corporation has elected to expense under section 179. Attach to each Schedule K-1 a separate schedule in a format similar to that shown on Form 3468 detailing each shareholder's pro rata share of qualified expenditures. Also indicate the lines of Form 3468 on which the shareholders should report these amounts.
Recapture of investment credit. Complete and attach Form 4255, Recapture of Investment Credit, when investment credit property is disposed of, or it no longer qualifies for the credit, before the end of the recapture period or the useful life applicable to the property. State the type of property at the top of Form 4255, and complete lines 2, 4, and 5, whether or not any shareholder is subject to recapture of the credit. Attach to each Schedule K-1 a separate schedule providing the information the corporation is required to show on Form 4255, but list only the shareholder's pro rata share of the cost of the property subject to recapture. Also indicate the lines of Form 4255 on which the shareholders should report these amounts.

The corporation itself is liable for investment credit recapture in certain cases. See the instructions for line 22c, page 1, Form 1120S, for details.
Any information needed by a shareholder to compute the recapture of the qualified electric vehicle credit. See Pub. 535 for more information.
Recapture of new markets credit (Form 8874).
Any information a shareholder may need to figure recapture of the Indian employment credit. Generally, if the corporation terminates a qualified employee less than 1 year after the date of initial employment, any Indian employment credit allowed for a prior tax year by reason of wages paid or incurred to that employee must be recaptured. For details, see section 45A(d).
Nonqualified withdrawals by the corporation from a capital construction fund.
Unrecaptured section 1250 gain. Figure this amount for each section 1250 property in Part III of Form 4797 (except property for which gain is reported using the installment method on Form 6252) for which you had an entry in Part I of Form 4797 by subtracting line 26g of Form 4797 from the smaller of line 22 or line 24 of Form 4797. Figure the total of these amounts for all section 1250 properties. Generally, the result is the corporation's unrecaptured section 1250 gain. However, if the corporation is reporting gain on the installment method for a section 1250 property held more than 1 year, see the next paragraph to figure the unrecaptured section 1250 gain on that property allocable to this tax year. Report each shareholder's pro rata share of the total amount as “Unrecaptured section 1250 gain.”

The total unrecaptured section 1250 gain for an installment sale of section 1250 property held more than 1 year is figured in a manner similar to that used in the preceding paragraph. However, the total unrecaptured section 1250 gain must be allocated to the installment payments received from the sale. To do so, the corporation generally must treat the gain allocable to each installment payment as unrecaptured section 1250 gain until all such gain has been used in full. Figure the unrecaptured section 1250 gain for installment payments received during the tax year as the smaller of (a) the amount from line 26 or line 37 of Form 6252 (whichever applies) or (b) the total unrecaptured section 1250 gain for the sale reduced by all gain reported in prior years (excluding section 1250 ordinary income recapture). However, if the corporation chose not to treat all of the gain from payments received after May 6, 1997, and before August 24, 1999, as unrecaptured section 1250 gain, use only the amount the corporation chose to treat as unrecaptured section 1250 gain for those payments to reduce the total unrecaptured section 1250 gain remaining to be reported for the sale.

If the corporation received a Schedule K-1 or Form 1099-DIV from an estate, a trust, a REIT, or a mutual fund reporting “unrecaptured section 1250 gain,” do not add it to the corporation's own unrecaptured section 1250 gain. Instead, report it as a separate amount. For example, if the corporation received a Form 1099-DIV from a REIT with unrecaptured section 1250 gain, report it as “Unrecaptured section 1250 gain from a REIT.”

Also report as a separate amount any gain from the sale or exchange of an interest in a partnership attributable to unrecaptured section 1250 gain. See Regulations section 1.1(h)-1 and attach a statement required under Regulations section 1.1(h)-1(e).
28% rate gain (loss). Figure this amount attributable to collectibles from the amount reported on Schedule D (Form 1120S) line 14. A collectibles gain (loss) is any long-term gain or deductible long-term loss from the sale or exchange of a collectible that is a capital asset.

Collectibles include works of art, rugs, antiques, metal (such as gold, silver, platinum bullion), gems, stamps, coin, alcoholic beverages, and certain other tangible property.

Also, include gain (but not loss) from the sale or exchange of an interest in a partnership or trust held for more than 1 year and attributable to unrealized appreciation of collectibles. For details, see Regulations section 1.1(h)-1. Also attach the statement required under Regulations section 1.1(h)-1(e).
Qualified 5-year gain. Attach a statement to each Schedule K-1 indicating the amount of net long-term gain (not losses) from the disposition of assets (excluding stock that could qualify for section 1202 gain) held more than 5 years that are portfolio income included on line 14 of Schedule D (Form 1120S). Also indicated the aggregate amount of all section 1231 gains from property held more than 5 years. Qualified 5-year gains should be reported only for the portion of the tax year before May 6, 2003. Do not include any section 1231 gain attributable to straight-line depreciation from section 1250 property. Indicate on the statement that this amount should be included in the shareholder's computation of qualified 5-year gain only if the amount on the shareholder's Form 4797, line 7, column (g), is more than zero, and that none of the gain is unrecaptured section 1250 gain.
If the corporation is a closely held S corporation (defined in section 460(b)(4)) and it depreciated certain property placed in service after September 13, 1995, under the income forecast method, it must attach to Form 1120S the information specified in the instructions for Form 8866, line 2, for the 3rd and 10th tax years beginning after the tax year the property was placed in service. It must also report the line 2 amounts to its shareholders. See the Instructions for Form 8866 for more details.
Amortization of reforestation expenditures. Report the amortizable basis and year in which the amortization began for the current year and the 7 preceding years. For limits that may apply, see section 194 and Pub. 535.
Any information needed by a shareholder to figure the interest due under section 1260(b). If any portion of a constructive ownership transaction was open in any prior year, each shareholder's tax liability must be increased by the shareholder's pro rata share of interest due on any deferral of gain recognition. See section 1260(b) for details, including how to figure the interest.
Any information needed by a shareholder to figure the extraterritorial income exclusion. See Extraterritorial Income Exclusion on page 12 for more information.
Commercial revitalization deduction from rental real estate activities. See Line 19—Other Deductions for the Special Rules that apply to the deduction.
If the corporation participates in a transaction that must be disclosed on Form 8886 (see page 7), both the corporation and its shareholders may be required to file Form 8886. The corporation must determine if any of its shareholders are required to disclose the transaction and provide those shareholders with information they will need to file Form 8886. This determination is based on the category(s) under which a transaction qualified for disclosures. See the instructions for Form 8886 for details.
Recapture of the credit for employer-provided child care facilities and services (Form 8882).
Any other information the shareholders need to prepare their tax returns.

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Schedule M-2 Worksheet

Schedule L. Balance Sheets per Books

The balance sheets should agree with the corporation's books and records. Include certificates of deposit as cash on line 1 of Schedule L.

If the S election terminated during the tax year, the year-end balance sheet generally should agree with the books and records at the end of the C short year. However, if the corporation elected under section 1362(e)(3) to have items assigned to each short year under normal tax accounting rules, the year-end balance sheet should agree with the books and records at the end of the S short year.

Line 5. Tax-Exempt Securities

Include on this line:

State and local government obligations, the interest on which is excludible from gross income under section 103(a), and
Stock in a mutual fund or other regulated investment company that distributed exempt-interest dividends during the tax year of the corporation.

Line 24. Retained Earnings

If the corporation maintains separate accounts for appropriated and unappropriated retained earnings, it may want to continue such accounting for purposes of preparing its financial balance sheet. Also, if the corporation converts to C corporation status in a subsequent year, it will be required to report its appropriated and unappropriated retained earnings on separate lines of Schedule L of Form 1120.

Line 25. Adjustments to Shareholders' Equity

Some examples of adjustments to report on this line include:

Unrealized gains and losses on securities held “available for sale.”
Foreign currency translation adjustments.
The excess of additional pension liability over unrecognized prior service cost.
Guarantees of employee stock (ESOP) debt.
Compensation related to employee stock award plans.

If the total adjustment to be entered is a negative amount, enter the amount in parentheses.

Schedule M-1. Reconciliation of Income (Loss) per Books With Income (Loss) per Return

Line 3b. Travel and Entertainment

Include on this line:

Meals and entertainment not allowed under section 274(n).
Expenses for the use of an entertainment facility.
The part of business gifts over $25.
Expenses of an individual allocable to conventions on cruise ships over $2,000.
Employee achievement awards over $400.
The part of the cost of entertainment tickets that exceeds face value (also subject to 50% limit).
The part of the cost of skyboxes that exceeds the face value of nonluxury box seat tickets.
The part of the cost of luxury water travel not allowed under section 274(m).
Expenses for travel as a form of education; nondeductible club dues.
Other travel and entertainment expenses.

Schedule M-2. Analysis of Accumulated Adjustments Account, Other Adjustments Account, and Shareholders' Undistributed Taxable Income Previously Taxed

Column (a). Accumulated Adjustments Account

The accumulated adjustments account (AAA) is an account of the S corporation that generally reflects the accumulated undistributed net income of the corporation for the corporation's post-1982 years. S corporations with accumulated E&P must maintain the AAA to determine the tax effect of distributions during S years and the post-termination transition period. An S corporation without accumulated E&P does not need to maintain the AAA in order to determine the tax effect of distributions. Nevertheless, if an S corporation without accumulated E&P engages in certain transactions to which section 381(a) applies, such as a merger into an S corporation with accumulated E&P, the S corporation must be able to calculate its AAA at the time of the merger for purposes of determining the tax effect of post-merger distributions. Therefore, it is recommended that the AAA be maintained by all S corporations.

On the first day of the corporation's first tax year as an S corporation, the balance of the AAA is zero. At the end of the tax year, adjust the AAA for the items for the tax year as explained below and in the order listed.

Increase the AAA by income (other than tax-exempt income) and the excess of the deduction for depletion over the basis of the property subject to depletion (unless the property is an oil and gas property the basis of which has been allocated to shareholders).
Generally, decrease the AAA by deductible losses and expenses, nondeductible expenses (other than expenses related to tax-exempt income and Federal taxes attributable to a C corporation tax year), and the sum of the shareholders' deductions for depletion for any oil or gas property held by the corporation as described in section 1367(a)(2)(E). However, if the total decreases under 2 exceeds the total increases under 1 above, the excess is a "net negative adjustment." If the corporation has a net negative adjustment, do not take it into account under 2. Instead, take it into account only under 4 below.
Decrease AAA (but not below zero) by property distributions (other than dividend distributions from accumulated E&P), unless the corporation elects to reduce accumulated E&P first. See Distributions below for definitions and other details.
Decrease AAA by any net negative adjustment. For adjustments to the AAA for redemptions, reorganizations, and corporate separations, see Regulations section 1.1368-2(d).

Note:

The AAA may have a negative balance at year end. See section 1368(e).

Column (b). Other Adjustments Account

The other adjustments account is adjusted for tax-exempt income (and related expenses) and Federal taxes attributable to a C corporation tax year. After these adjustments are made, the account is reduced for any distributions made during the year. See Distributions below.

Column (c). Shareholders' Undistributed Taxable Income Previously Taxed

The shareholders' undistributed taxable income previously taxed account, also called previously taxed income (PTI), is maintained only if the corporation had a balance in this account at the start of its 2003 tax year. If there is a beginning balance for the 2003 tax year, no adjustments are made to the account except to reduce the account for distributions made under section 1375(d) (as in effect before the enactment of the Subchapter S Revision Act of 1982). See Distributions below for the order of distributions from the account.

Each shareholder's right to nontaxable distributions from PTI is personal and cannot be transferred to another person. The corporation is required to keep records of each shareholder's net share of PTI.

Distributions

General rule. Unless the corporation makes one of the elections described below, property distributions (including cash) are applied in the following order to reduce accounts of the S corporation that are used to figure the tax effect of distributions made by the corporation to its shareholders:

Reduce the AAA determined without regard to any net negative adjustment for the tax year (but not below zero). If distributions during the tax year exceed the AAA at the close of the tax year determined without regard to any net negative adjustment for the tax year, the AAA is allocated pro rata to each distribution made during the tax year. See section 1368(c).
Reduce shareholders' PTI account for any section 1375(d) (as in effect before 1983) distributions. A distribution from the PTI account is tax free to the extent of a shareholder's basis in his or her stock in the corporation.
Reduce accumulated E&P. Generally, the S corporation has accumulated E&P only if it has not distributed E&P accumulated in prior years when the S corporation was a C corporation (section 1361(a)(2)). See section 312 for information on E&P. The only adjustments that can be made to the accumulated E&P of an S corporation are (a) reductions for dividend distributions; (b) adjustments for redemptions, liquidations, reorganizations, etc.; and (c) reductions for investment credit recapture tax for which the corporation is liable. See sections 1371(c) and (d)(3).
Reduce the other adjustments account.
Reduce any remaining shareholders' equity accounts.

Elections relating to source of distributions. The corporation may modify the above ordering rules by making one or more of the following elections:

Election to distribute accumulated E&P first. If the corporation has accumulated E&P and wants to distribute this E&P before making distributions from the AAA, it may elect to do so with the consent of all its affected shareholders (section 1368(e)(3)(B)). This election is irrevocable and applies only for the tax year for which it is made. For details on making the election, see Statement regarding elections below.
Election to make a deemed dividend. If the corporation wants to distribute all or part of its accumulated E&P through a deemed dividend, it may elect to do so with the consent of all its affected shareholders (section 1368(e)(3)(B)). Under this election, the corporation will be treated as also having made the election to distribute accumulated E&P first. The amount of the deemed dividend cannot exceed the accumulated E&P at the end of the tax year, reduced by any actual distributions of accumulated E&P made during the tax year. A deemed dividend is treated as if it were a pro rata distribution of money to the shareholders, received by the shareholders, and immediately contributed back to the corporation, all on the last day of the tax year. This election is irrevocable and applies only for the tax year for which it is made. For details on making the election, see Statement regarding elections below.
Election to forego PTI. If the corporation wants to forego distributions of PTI, it may elect to do so with the consent of all its affected shareholders (section 1368(e)(3)(B)). Under this election, paragraph 2 under the General rule above does not apply to any distribution made during the tax year. This election is irrevocable and applies only for the tax year for which it is made. For details on making the election, see Statement regarding elections below.

Statement regarding elections. To make any of the above elections, the corporation must attach a statement to a timely filed original or amended Form 1120S for the tax year for which the election is made. In the statement, the corporation must identify the election it is making and must state that each shareholder consents to the election. The statement of election to make a deemed dividend must include the amount of the deemed dividend distributed to each shareholder. For more details on the election, see Temporary Regulations section 1.1368-1T(f)(5).

Example

The following example shows how the Schedule M-2 accounts are adjusted for items of income (loss), deductions, and distributions reported on Form 1120S. In this example, the corporation has no PTI or accumulated E&P.

Items per return are:

Page 1, line 21 income—$10,000
Schedule K, line 2 loss—($3,000)
Schedule K, line 4a income—$4,000
Schedule K, line 4b(2) income—$16,000
Schedule K, line 7 deduction—$24,000
Schedule K, line 10 deduction—$3,000
Schedule K, line 13 work opportunity credit—$6,000
Schedule K, line 17 tax-exempt interest—$5,000
Schedule K, line 19 nondeductible expenses—$6,000 (reduction in salaries and wages for work opportunity credit), and
Schedule K, line 20 distributions—$65,000.

Based on return items 1 through 10 and starting balances of zero, the columns for the AAA and the other adjustments account are completed as shown in the Schedule M-2 Worksheet below.

For the AAA, the worksheet line 3—$20,000 amount is the total of the Schedule K, lines 4a and 4b(2) income of $4,000 and $16,000. The worksheet line 5—$36,000 amount is the total of the Schedule K, line 2 loss of ($3,000), line 7 deduction of $24,000, line 10 deduction of $3,000, and the line 19 nondeductible expenses of $6,000. The worksheet line 7 is zero. The AAA at the end of the tax year (figured without regard to distributions and the net negative adjustment of $6,000) is zero, and distributions cannot reduce the AAA below zero.

For the other adjustments account, the worksheet line 3 amount is the Schedule K, line 17, tax-exempt interest income of $5,000. The worksheet line 7 amount is $5,000, reducing the other adjustments account to zero. The remaining $60,000 of distributions are not entered on Schedule M-2.

Paperwork Reduction Act Notice.

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The time needed to complete and file this form and related schedules will vary depending on individual circumstances. The estimated average times are:

Form	Recordkeeping	Learning about the law or the form	Preparing the form	Copying, assembling, and sending the form to the IRS
1120S	65 hr., 45 min.	25 hr., 11 min.	47 hr., 44 min.	5 hr., 54 min.
Sch. D (1120S)	10 hr., 2 min.	4 hr., 31 min.	9 hr., 32 min.	1 hr., 20 min.
Sch. K-1 (1120S)	16 hr., 58 min.	10 hr., 36 min.	15 hr., 4 min.	1 hr., 4 min.

We Welcome Comments on Forms. If you have comments concerning the accuracy of these time estimates or suggestions for making these forms simpler, we would be happy to hear from you. You can write to the Tax Products Coordinating Committee, Western Area Distribution Center, Rancho Cordova, CA 95743-0001. Do not send the tax form to this address. Instead, see Where To File on page 3.

Instructions for Form 1120S - Notices