S Corporation entities offer several benefits to owners but can be complicated when it comes to filing tax returns. As per Mike Piper’s 3-Minute Video, definitely plan on higher legal and accounting fees!
In S-Corporation Accounting, William Perez writes about the difficulty involved in computing Shareholder Stock Basis, which must be calculated on the last day of the taxable year to figure out how much passive income or loss to pass through to each shareholder.
The IRS provides an overview of calculating shareholder Stock and Debt basis here, and a worksheet in the Instructions for Schedule K-1 (Form 1120S), but the Perez article provides a calculation that is easier to read and also has a calculation for computing the Loan Basis and the Amount at Risk.
Taxpayers may be able to deduct passive activity losses against passive activity income subject to restrictions explained in IRS Publication 925. If S Corporation shareholders do not materially participate in the business activity, losses are passive hence can be deducted against passive income but are not otherwise generally deductible.
Shareholders can only deduct losses to the extent that they have sufficient basis in the Stock and Debt of the S Corporation, and to the extent that they have a sufficient amount “at risk” with respect to their S Corp investment. Chapter 10 of the California Franchise Tax Board (CFTB) Internal Procedures Manual – S-Corporation Manual details at-risk limitations; page 2 of the Perez article shows the calculation as Adjust Stock Basis + Adjusted Loan Basis = Amount at Risk.
This QuickBooks forum thread notes that the Accumulated Adjustments Account (see Chapter 10 of the CFTB Internal Procedures Manual – S-Corporation Manual) is the same as the default Retained Earnings account–the account holding undistributed earnings. This account may have a negative balance if the S Corporation has had more loss than income.
My S Corporation clients generally use CPAs to prepare their S Corporation and individual returns due to the above tax complexities, and because their QuickBooks balance sheet accounts are typically not sufficiently well maintained to allow for easy calculation of shareholder basis.
Whether or not you use tax professionals to prepare your S Corporation and individual returns, it’s a good idea to keep the QuickBooks balance sheet accounts in good order to minimize legal and accounting expenses. For example, if your CPA computes the basis for a given tax year, make sure corresponding QuickBooks balance sheet account balances match those used in the basis calculation. If they don’t, ask your CPA to make or provide a QuickBooks journal entry to adjust the accounts so they match your filed return.
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Thanks to Kay Bell for including this article in her Tax Carnival #59: Standard Tax Time