2003 HTML Instructions for Form 1120-FSC,

This is archived information that pertains only to the 2003 Tax Year. If you
are looking for information for the current tax year, go to the Tax Prep Help Area.

Purpose of Form

Use Form 1120-FSC to report the income, gains, losses, deductions, credits, and to figure the income tax liability of a FSC.

FSC Repeal and Extraterritorial Income Exclusion

In general, the FSC Repeal and Extraterritorial Income Exclusion Act of 2000:

Repealed the FSC rules,
Provides taxpayers with an exclusion, which is figured on Form 8873, Extraterritorial Income Exclusion, and
Provides transition rules for existing FSCs (see Transition Rules below).

Transition Rules

In general, a FSC that was in existence on September 30, 2000, and at all times thereafter, may continue to use the FSC rules for qualifying transactions in the ordinary course of business that are pursuant to a binding contract between the FSC (or a person related to the FSC) and a person other than a related person if that binding contract was in effect on September 30, 2000, and has remained in effect. A binding contract includes a purchase, renewal, or replacement option that is enforceable against a lessor or seller (provided the option is part of a contract that is binding and in effect on September 30, 2000, and has remained in effect).

The mere entering into of a single transaction, such as a lease, would not, in and of itself, prevent the transaction from being in the ordinary course of business.

Election To Apply Exclusion Rules

Taxpayers may elect to apply the extraterritorial income exclusion rules instead of the FSC rules for transactions occurring during the transition period. The election is:

Made by checking the box on line 2 of Form 8873,
Made on a transaction-by-transaction basis,
Effective for the tax year for which it is made and for all subsequent tax years, and
Revocable only with the consent of the IRS.

Taxpayers use Form 8873 to determine their extraterritorial income exclusion.

Election To Be Treated as a Domestic Corporation

A FSC that was in existence on September 30, 2000, and at all times thereafter, may elect to be treated as a domestic corporation if substantially all of its gross receipts are foreign trading gross receipts.

The election is made by checking the box on line 3 of Form 8873. An electing corporation files Form 1120, U.S. Corporation Income Tax Return, or Form 1120-A, U.S. Corporation Short-Form Income Tax Return. Once made, the election applies to the tax year for which it is made and remains in effect for all subsequent years unless the election is revoked or terminated. If the election is revoked or terminated, the corporation would be a foreign corporation that files Form 1120-F, U.S. Income Tax Return of a Foreign Corporation. Furthermore, the foreign corporation would not be eligible to reelect to be treated as a domestic corporation for 5 tax years beginning with the first tax year for which the original election is not in effect as a result of the revocation or termination.

Effect of election. A FSC that elects to be treated as a domestic corporation ceases to be a FSC for any tax year for which the election applies (and for any subsequent tax year).

FSC Election

No corporation may elect to be a FSC or a small FSC (defined below) after September 30, 2000.

Termination of Inactive FSCs

If a FSC has no foreign trade income (see definition under Tax Treatment of a FSC below) for any 5 consecutive tax years beginning after December 31, 2001, the FSC will no longer be treated as a FSC for any tax year beginning after that 5-year period.

Additional Information

For additional information regarding the rules discussed above, see Rev. Proc. 2001-37, 2001-23 I.R.B. 1327.

FSC Rules

Definition of a Foreign
Sales Corporation (FSC)

Under section 922(a), a FSC is defined as a corporation that has met all of the following rules.

It must be a corporation created or organized under the laws of a qualifying foreign country or any U.S. possession other than Puerto Rico.

Qualifying U.S. possessions include Guam, American Samoa, the Commonwealth of the Northern Mariana Islands, and the U.S. Virgin Islands.

A qualifying foreign country is a foreign country that meets the exchange of information rules of section 927(e)(3)(A) or (B). All U.S. possessions other than Puerto Rico are also certified to have met these rules.

The following countries are qualifying foreign countries that have met the exchange of information rules of section 927(e)(3)(A) or 927(e)(3)(B): Australia, Austria, Barbados, Belgium, Bermuda, Canada, Costa Rica, Cyprus, Denmark, Dominica, the Dominican Republic, Egypt, Finland, France, Germany, Grenada, Guyana, Honduras, Iceland, Ireland, Jamaica, Korea, Malta, the Marshall Islands, Mexico, Morocco, the Netherlands, New Zealand, Norway, Pakistan, Peru, the Philippines, St. Lucia, Sweden, and Trinidad and Tobago.
It had no more than 25 shareholders at any time during the tax year.
It had no preferred stock outstanding at any time during the tax year.
During the tax year, the FSC must maintain:
- An office in one of the qualifying foreign countries or U.S. possessions listed above,
- A set of permanent books of account (including invoices) at that office, and
- The books and records required under section 6001 at a U.S. location to sufficiently establish the amount of gross income, deductions, credits, or other matters required to be shown on its tax return.
It must have at least one director, at all times during the tax year, who is not a resident of the United States.
It must not be a member, at any time during the tax year, of a controlled group of which a DISC is a member.
It must have elected to be a FSC or small FSC, and the election must have been in effect for the tax year.

Small FSC. Section 922(b) defines a small FSC as a corporation that:

Elected small FSC status and has kept the election in effect for the tax year and
Is not a member, at any time during the tax year, of a controlled group that includes a FSC (unless that other FSC is also a small FSC).

A small FSC is exempt from the foreign management and foreign economic process requirements. See the instructions for Foreign Management Rules and the Foreign Economic Process Rules on page 3.

$5 million limit. Generally, any foreign trading gross receipts of a small FSC for the tax year that exceed $5 million are not to be considered in determining its exempt foreign trade income. The $5 million limit is reduced if the small FSC has a short tax year. It may also be reduced if the small FSC is a member of a controlled group that contains other small FSCs. See Regulations section 1.921-2(b) for more information.

Tax Treatment of a FSC

A FSC is not taxed on its exempt foreign trade income. Section 923 defines foreign trade income as the gross income of a FSC attributable to foreign trading gross receipts (defined on page 3).

The percentage of foreign trade income exempt from tax is figured differently for income determined under the administrative pricing rules (for details, see the instructions for Schedule P (Form 1120-FSC)) and income determined without regard to the administrative pricing rules. These percentages are computed on Schedule E, page 4, Form 1120-FSC, and carried over to lines 9a and 9b of Schedule B, page 3, Form 1120-FSC, to figure taxable income or (loss).

See section 923(a)(4) for a special rule for foreign trade income allocable to a cooperative. See section 923(a)(5) for a special rule for military property.

Tax treaty benefits. A FSC may not claim any benefits under any income tax treaty between the United States and any foreign country.

Foreign Trading Gross Receipts

A FSC is treated as having foreign trading gross receipts (defined in section 924) only if it has met certain foreign management and foreign economic process requirements.

Foreign trading gross receipts do not include:

Certain excluded receipts (defined in section 924(f)).
Receipts attributable to property excluded from export property under section 927(a)(2).
Investment income (defined in section 927(c)).
Carrying charges (defined in section 927(d)(1)).

Note:

Computer software licensed for reproduction abroad is not excluded from export property under section 927(a)(2). Therefore, receipts attributable to the sale, lease, or rental of computer software and services related and subsidiary to such transactions qualify as foreign trading gross receipts.

Foreign Management Rules

A FSC (other than a small FSC) is treated as having foreign trading gross receipts for the tax year only if the management of the FSC during the year takes place outside the United States. These management activities include:

Meetings of the board of directors and meetings of the shareholders.
Disbursing cash, dividends, legal and accounting fees, salaries of officers, and salaries or fees of directors from the principal bank account (see below).
Maintaining the principal bank account at all times during the tax year.

Meetings of directors and meetings of the shareholders. All meetings of the board of directors of the FSC and all meetings of the shareholders of the FSC that take place during the tax year must take place outside the United States.

In addition, all such meetings must comply with the local laws of the foreign country or U.S. possession in which the FSC was created or organized. The local laws determine whether a meeting must be held, when and where it must be held (if it is held at all), who must be present, quorum requirements, use of proxies, etc.

Principal bank accounts. See Regulations section 1.924(c)-1(c) for information regarding principal bank accounts.

Foreign Economic Process Rules

A FSC (other than a small FSC) has foreign trading gross receipts from any transaction only if certain economic processes for the transaction take place outside the United States. Section 924(d) and Regulations section 1.924(d)-1 set forth the rules for determining whether a sufficient amount of the economic processes of a transaction takes place outside the United States.

Generally, a transaction will qualify if the FSC satisfies two requirements:

Participation outside the United States in the sales portion of the transaction and
Satisfaction of either the 50% or the 85% foreign direct cost test.

The activities comprising these economic processes may be performed by the FSC or by any other person acting under contract with the FSC.

Participation outside the United States in the sales portion of the transaction. Generally, the requirement of section 924(d)(1)(A) is met for the gross receipts of a FSC derived from any transaction if the FSC has participated outside the United States in the following sales activities relating to the transaction: (1) solicitation (other than advertising), (2) negotiation, and (3) making a contract.

Solicitation (other than advertising) is any communication (including, but not limited to, telephone, telegraph, mail, or in person) by the FSC, to a specific, targeted customer or potential customer.
Negotiation is any communication by the FSC to a customer or potential customer aimed at an agreement on one or more of the terms of a transaction, including, but not limited to, price, credit terms, quantity, or time or manner of delivery.
Making a contract refers to performance by the FSC of any of the elements necessary to complete a sale, such as making or accepting an offer.

Grouping transactions. Generally, the sales activities described above are to be applied on a transaction-by-transaction basis. However, a FSC may make an annual election to apply any of the sales activities on the basis of a group. To make the election, check the applicable box on line 11a, Additional Information, on page 2 of Form 1120-FSC. See Regulations section 1.924(d)-1(c)(5) for details.

Satisfaction of either the 50% or 85% foreign direct cost test. To qualify as foreign trading gross receipts, the foreign direct costs incurred by the FSC attributable to the transaction must equal or exceed 50% of the total direct costs incurred by the FSC attributable to the transaction.

Instead of satisfying the 50% foreign direct cost test, the FSC may incur foreign direct costs attributable to activities described in each of two of the section 924(e) categories. The costs must equal or exceed 85% of the total direct costs incurred by the FSC attributable to the activity described in each of the two categories. If no direct costs are incurred by the FSC in a particular category, that category is not taken into account for purposes of determining whether the FSC has met either the 50% or 85% foreign direct cost test.

Direct costs are costs that:

Are incident to and necessary for the performance of any activity described in section 924(e);
Include the cost of materials consumed in the performance of the activity and the cost of labor that can be identified or associated directly with the performance of the activity (but only to the extent of wages, salaries, fees for professional services, and other amounts paid for personal services actually rendered, such as bonuses or compensation paid for services on the basis of a percentage of profits); and
Include the allowable depreciation deduction for equipment or facilities (or the rental cost for its use) that can be specifically identified or associated with the activity, as well as the contract price of an activity performed on behalf of the FSC by a contractor.

Total direct costs means all of the direct costs of any transaction attributable to activities described in any paragraph of section 924(e). For purposes of the 50% test of section 924(d)(1)(B), total direct costs are based on the direct costs of all activities described in all paragraphs of section 924(e). For purposes of the 85% test of section 924(d)(2), however, the total direct costs are determined separately for each paragraph of section 924(e).

Foreign direct costs means the portion of the total direct costs of any transaction attributable to activities performed outside the United States. For purposes of the 50% test, foreign direct costs are based on the direct costs of all activities described in all paragraphs of section 924(e). For purposes of the 85% test, however, foreign direct costs are determined separately for each paragraph of section 924(e).

For more details, see Regulations section 1.924(d)-1(d).

Check the applicable box(es) on line 11b, Additional Information, on page 2 of the form, to indicate how the FSC met the foreign direct costs requirement.

Grouping transactions. Generally, the foreign direct cost tests under Regulations section 1.924(d)-1(d) are applied on a transaction-by-transaction basis. However, the FSC may make an annual election (on line 11d, Additional Information, on page 2 of the form) to apply the foreign direct cost tests on a customer, contract, or product or product line grouping basis. Any grouping used must be supported by adequate documentation of performance of activities and costs of activities relating to the grouping used. See Regulations section 1.924(d)-1(e) for details.

Exception for foreign military property. The economic process rules do not apply to any activities performed in connection with foreign military sales except those activities described in section 924(e). See Regulations section 1.924(d)-1(f) for details.

Section 925(c) Rule

To use the administrative pricing rules to determine the FSC's (or small FSC's) profit on a transaction or group of transactions, the FSC must perform (or contract with another person to perform) all of the economic process activities relating to the transaction or group of transactions. All of the direct and indirect expenses relating to the performance of those activities must be reflected on the books of the FSC and on Form 1120-FSC.

Under Temporary Regulations section 1.925(a)-1T(b)(2)(ii), an election may be made to include on the FSC's books all expenses, other than cost of goods sold, that are necessary to figure combined taxable income for the transaction or group of transactions. The expenses must be identified on Schedule G on the applicable line.

Who Must File

File Form 1120-FSC if the corporation elected to be treated as a FSC or small FSC, and the election is still in effect.

Note:

A FSC that elects to be treated as a domestic corporation under section 943(e)(1) does not file Form 1120-FSC. Instead, it files Form 1120 (or Form 1120-A).

When To File

Generally, a corporation must file Form 1120-FSC by the 15th day of the 3rd month after the end of its tax year. A FSC that has dissolved must generally file by the 15th day of the 3rd month after the date it dissolved.

If the due date falls on a Saturday, Sunday, or legal holiday, the FSC may file on the next business day.

Private delivery services. FSCs can use certain private delivery services designated by the IRS to meet the “timely mailing as timely filing/paying” rule for tax returns and payments. The most recent list of designated private delivery services was published by the IRS in September 2002.

The list includes only the following:

Airborne Express (Airborne): Overnight Air Express Service, Next Afternoon Service, and Second Day Service.
DHL Worldwide Express (DHL): DHL “Same Day” Service and DHL USA Overnight.
Federal Express (FedEx): FedEx Priority Overnight, FedEx Standard Overnight, FedEx 2Day, FedEx International Priority, and FedEx International First.
United Parcel Service (UPS): UPS Next Day Air, UPS Next Day Air Saver, UPS 2nd Day Air, UPS 2nd Day Air A.M., UPS Worldwide Express Plus, and UPS Worldwide Express.

The private delivery service can tell you how to get written proof of the mailing date.

Extension of time to file. File Form 7004, Application for Automatic Extension of Time To File Corporation Income Tax Return, to request a 6-month extension of time to file.

Where To File

File Form 1120-FSC with the Internal Revenue Service Center, Philadelphia, PA 19255.

Who Must Sign

The return must be signed and dated by:

The president, vice president, treasurer, assistant treasurer, chief accounting officer or
Any other corporate officer (such as tax officer) authorized to sign.

Receivers, trustees, or assignees must also sign and date any return filed on behalf of a corporation.

If an employee of the corporation completes Form 1120-FSC, the paid preparer's space should remain blank. Anyone who prepares Form 1120-FSC but does not charge the corporation should not complete that section. Generally, anyone who is paid to prepare the return must sign it and fill in the “Paid Preparer's Use Only” area.

The paid preparer must complete the required preparer information and—

Sign the return in the space provided for the preparer's signature.
Give a copy of the return to the taxpayer.

Paid Preparer Authorization

If the FSC wants to allow the IRS to discuss its 2003 tax return with the paid preparer who signed it, check the “Yes” box in the signature area of the return. This authorization applies only to the individual whose signature appears in the “Paid Preparer's Use Only” section of the FSC's return. It does not apply to the firm, if any, shown in that section.

If the “Yes” box is checked, the FSC is authorizing the IRS to call the paid preparer to answer any questions that may arise during the processing of its return. The FSC is also authorizing the paid preparer to:

Give the IRS any information that is missing from the return,
Call the IRS for information about the processing of the return or the status of any related refund or payment(s), and
Respond to certain IRS notices that the FSC has shared with the preparer about math errors, offsets, and return preparation. The notices will not be sent to the preparer.

The FSC is not authorizing the paid preparer to receive any refund check, bind the FSC to anything (including any additional tax liability), or otherwise represent the FSC before the IRS. If the FSC wants to expand the paid preparer's authorization, see Pub. 947, Practice Before the IRS and Power of Attorney.

The authorization cannot be revoked. However, the authorization will automatically end no later than the due date (excluding extensions) for filing the FSC's 2004 tax return.

Other Forms, Schedules,
and Statements That
May Be Required

The FSC may have to file some of the following forms. See the form for more information.

Form W-2, Wage and Tax Statement, and Form W-3, Transmittal of Wage and Tax Statements. Use these forms to report wages, tips, and other compensation, and withheld income, social security, and Medicare taxes for employees.
Form 940 or Form 940-EZ, Employer's Annual Federal Unemployment (FUTA) Tax Return. The FSC may be liable for FUTA tax and may have to file Form 940 or Form 940-EZ if it either:
1. Paid wages of $1,500 or more in any calendar quarter in 2002 or 2003 or
2. Had one or more employees who worked for the FSC for at least some part of a day in any 20 or more different weeks in 2002 or 20 or more different weeks in 2003.
Form 941, Employer's Quarterly Federal Tax Return. Employers must file this form to report income tax withheld, and employer and employee social security and Medicare taxes. Also, see Trust fund recovery penalty on page 7.
Form 945, Annual Return of Withheld Federal Income Tax. File Form 945 to report income tax withheld from nonpayroll distributions or payments. Also, see Trust fund recovery penalty on page 7.
Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons,
Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding, and
Form 1042-T, Annual Summary and Transmittal of Forms 1042-S. Use these forms to report and send withheld tax on payments or distributions made to nonresident alien individuals, foreign partnerships, or foreign corporations to the extent these payments constitute gross income from sources within the United States (see sections 861 through 865).

Also, see Pub. 515, Withholding of Tax on Nonresident Aliens and Foreign Entities, and sections 1441 and 1442.
Form 1096, Annual Summary and Transmittal of U.S. Information Returns.
Forms 1099. Use these information returns to report the following:
Note:

Every corporation must file Form 1099-MISC if it makes payments of rents, commissions, or other fixed or determinable income (see section 6041) totaling $600 or more to any one U.S. person in the course of its trade or business during the calendar year.
1. 1099-A, Acquisition or Abandonment of Secured Property.
2. 1099-B, Proceeds From Broker and Barter Exchange Transactions.
3. 1099-C, Cancellation of Debt.
4. 1099-DIV, Dividends and Distributions.
5. 1099-INT, Interest Income.
6. 1099-MISC, Miscellaneous Income. Use this form to report payments: to providers of health and medical services, of rent or royalties, of nonemployee compensation, etc.
7. 1099-OID, Original Issue Discount.
Also use these returns to report amounts received as a nominee for another person.
Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations. This form may have to be filed by certain U.S. officers, directors, or shareholders of a FSC to report changes in ownership (see sections 6046 and the related regulations).

If a Form 1120-FSC is filed, Form 5471 is not required to be filed to satisfy the requirements of section 6038 (see Temporary Regulations section 1.921-1T(b)(3)). However, certain U.S. shareholders may be required to file Form 5471 and the applicable schedules to report subpart F income.

Certain U.S. officers, directors, and shareholders of a FSC that is a foreign personal holding company may have to file Form 5471 and appropriate schedules. See Foreign personal holding company on this page for details.

See the instructions for Form 5471 for more information.
Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. Generally, a FSC that is engaged in a trade or business in the United States that had a reportable transaction with a foreign or domestic related party during the tax year must file Form 5472.
Form 5713, International Boycott Report. FSCs that had operations in, or related to, certain “boycotting” countries file Form 5713.
Form 8264, Application for Registration of a Tax Shelter. Tax shelter organizers use this form to receive a tax shelter registration number from the IRS.
Form 8271, Investor Reporting of Tax Shelter Registration Number. FSCs, which have acquired an interest in a tax shelter that is required to be registered, use this form to report the tax shelter's registration number. Attach Form 8271 to any tax return (including an application for tentative refund (Form 1139) and an amended return) on which a deduction, credit, loss, or other tax benefit attributable to a tax shelter is taken or any income attributable to a tax shelter is reported.
Form 8275, Disclosure Statement, and Form 8275-R, Regulation Disclosure Statement. Disclose items or positions taken on a tax return that are not otherwise adequately disclosed on a tax return or that are contrary to Treasury regulations (to avoid parts of the accuracy-related penalty or certain preparer penalties).
Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business. Use this form to report the receipt of more than $10,000 in cash or foreign currency in one transaction or a series of related transactions.
Form 8810, Corporate Passive Activity Loss and Credit Limitations. Closely held FSCs (and FSCs that are personal service corporations) must use this form to compute the passive activity loss and credit allowed under section 469.
Form 8842, Election To Use Different Annualization Periods for Corporate Estimated Tax. FSCs use Form 8842 for each year they want to elect one of the annualization periods in section 6655(e)(2) for figuring estimated tax payments under the annualized income installment method.
Form 8866, Interest Computation Under the Look-Back Method for Property Depreciated Under the Income Forecast Method. Figure the interest due or to be refunded under the look-back method of section 167(g)(2) for property placed in service after September 13, 1995, that is depreciated under the income forecast method.
Form 8886, Reportable Transaction Disclosure Statement. Use this form to disclose information for each reportable transaction in which the FSC participated. Form 8886 must be filed for each tax year that the Federal Income tax liability of the FSC is affected by its participation in the transaction. The following are reportable transactions.
1. Any transaction that is the same as or substantially similar to tax avoidance transactions identified by the IRS.
2. Any transaction offered under conditions of confidentiality.
3. Any transaction for which the FSC has contractual protection against disallowance of the tax benefits.
4. Any transaction resulting in a loss of at least $10 million in any single year or $20 million in any combination of years.
5. Any transaction resulting in a book-tax difference of more than $10 million on a gross basis. For exceptions, see Rev. Proc. 2003-24, 2003-11 I.R.B. 599, and Rev. Proc. 2003-25, 2003-11 I.R.B. 601.
6. Any transaction resulting in a tax credit of more than $250,000, if the FSC held the asset generating the credit for 45 days or less.
Schedule P (Form 1120-FSC), Transfer Price or Commission. Complete and attach Schedule P, as appropriate, using the administrative pricing rules of section 925.

Personal Holding Companies and Foreign Personal Holding Companies

Personal holding company. A FSC that is a personal holding company (as defined in section 542) but not a foreign personal holding company, must file Schedule PH (Form 1120), U.S. Personal Holding Company (PHC) Tax, with Form 1120-FSC. On line 8, Schedule J, Form 1120-FSC, the FSC reports the personal holding company tax. See section 542 and Schedule PH (Form 1120) for details.

Foreign personal holding company. Regulations section 1.551-4 requires certain shareholders of a FSC that is a foreign personal holding company (as defined in section 552) to attach a statement to their personal returns containing the information required by section 551(c).

Form 5471. Section 6035 and the related regulations require certain U.S. officers, directors, and shareholders of a foreign personal holding company to file Schedule N (Form 5471), Return of Officers, Directors, and 10% or More Shareholders of a Foreign Personal Holding Company, and the appropriate schedules of Form 5471. See the Instructions for Form 5471 for additional information.

Assembling the Return

To ensure that the FSC's tax return is correctly processed, attach all schedules and other forms after page 6, Form 1120-FSC, and in the following order.

Form 4136.
Form 4626.
Form 851.
Additional schedules in alphabetical order.
Additional forms in numerical order.

Complete every applicable entry space on Form 1120-FSC. Do not write “See attached” instead of completing the entry spaces. If more space is needed on the forms or schedules, attach separate sheets using the same size and format as the printed forms. If there are supporting statements and attachments, arrange them in the same order as the schedules or forms they support and attach them last. Show the totals on the printed forms. Also, be sure to enter the FSC's name and EIN on each supporting statement or attachment.

Accounting Methods

An accounting method is a set of rules used to determine when and how income and expenses are reported. Figure taxable income using the method of accounting regularly used in keeping the FSC's books and records. In all cases, the method used must clearly show taxable income.

Generally, permissible methods include:

Cash,
Accrual, or
Any other method authorized by the Internal Revenue Code.

A member of a controlled group cannot use an accounting method that would distort any group member's income, including its own. For example, a FSC acts as a commission agent for property sales by a related corporation that uses the accrual method and pays the FSC its commission more than 2 months after the sale. In this case, the FSC should not use the cash method because that method would materially distort its income.

Accrual method. Generally, a FSC (other than a qualified personal service corporation) must use the accrual method of accounting if its average annual gross receipts exceed $5 million. See section 448(c).

If inventories are required, the accrual method generally must be used for sales and purchases of merchandise. However, qualifying taxpayers and eligible businesses of qualifying small business taxpayers are excepted from using the accrual method for eligible trades or businesses and may account for inventoriable items as materials and supplies that are not incidental. For details, see Schedule A, Cost of Goods Sold Related to Foreign Trading Gross Receipts, on page 8.

Under the accrual method, an amount is includible in income when:

All the events have occurred that fix the right to receive the income, which is the earliest of the date: (a) the required performance takes place, (b) payment is due, or (c) payment is received, and
The amount can be determined with reasonable accuracy.

See Regulations section 1.451-1(a) for details.

Generally, an accrual basis taxpayer can deduct accrued expenses in the tax year when:

All events that determine the liability have occurred,
The amount of the liability can be figured with reasonable accuracy, and
Economic performance takes place with respect to the expense.

There are exceptions to the economic performance rule for certain items, including recurring expenses. See section 461(h) and the related regulations for the rules for determining when economic performance takes place.

Nonaccrual experience method. Accrual method corporations are not required to accrue certain amounts to be received from the performance of certain services that, on the basis of their experience, will not be collected, if the corporation's average annual gross receipts for the 3 prior years does not exceed $5 million.

This provision does not apply to any amount if interest is required to be paid on the amount or if there is any penalty for failure to timely pay the amount. For more information, see section 448(d)(5) and Temporary Regulations section 1.448-2T. For reporting requirements, see the instructions for Schedule B on page 10.

Change in accounting method. To change its method of accounting used to report taxable income (for income as a whole or for any material item), the FSC must file Form 3115, Application for Change in Accounting Method. For more information, see Form 3115 and Pub. 538, Accounting Periods and Methods.

Section 481(a) adjustment. The FSC may have to make an adjustment under section 481(a) to prevent amounts of income or expense from being duplicated or omitted. The section 481(a) adjustment period is generally 1 year for a net negative adjustment and 4 years for a net positive adjustment. However, a FSC may elect to use a 1-year adjustment period if the net section 481(a) adjustment for the change is less than $25,000. The FSC must complete the appropriate lines of Form 3115 to make the election.

Accounting Periods

A FSC must figure its taxable income on the basis of a tax year. A tax year is the annual accounting period a FSC uses to keep its records and report its income and expenses. Generally, FSCs can use a calendar year or a fiscal year. Personal service corporations, however, must generally use a calendar year.

Note:

The tax year of a FSC must be the same as the tax year of the principal shareholder which, at the beginning of the FSC tax year, has the highest percentage of voting power. If two or more shareholders have the highest percentage of voting power, the FSC must have a tax year that conforms to the tax year of any such shareholder. See section 441(h).

Calendar year. If the FSC is required to use the calendar year as its annual accounting period, the FSC must maintain its books and records and report its income and expenses for the period from January 1 through December 31 of each year.

Fiscal year. A fiscal year is 12 consecutive months ending on the last day of any month except December. A 52-53 week year is a fiscal year that varies from 52 to 53 weeks.

Rounding Off To
Whole Dollars

The FSC may round off cents to whole dollars on its return and schedules. If the FSC does round to whole dollars, it must round all amounts. To round, drop amounts under 50 cents and increase amounts from 50 to 99 cents to the next dollar (for example, $1.39 becomes $1 and $2.50 becomes $3).

If two or more amounts must be added to figure the amount to enter on a line, include cents when adding the amounts and round off only the total.

Recordkeeping

Keep the FSC's records for as long as they may be needed for the administration of any provision of the Internal Revenue Code. Usually, records that support an item of income, deduction, or credit on the return must be kept for 3 years from the date the return is due or filed, whichever is later. Keep records that verify the FSC's basis in property for as long as they are needed to figure the basis of the original or replacement property.

The FSC should keep copies of all filed returns. They help in preparing future and amended returns.

Payment of Tax Due

The FSC must pay the tax due in full no later than the 15th day of the 3rd month after the end of the tax year. The method for payment of the tax due depends upon whether the FSC has an office or place of business in the United States.

FSCs that do not maintain an office or place of business in the United States must pay the tax due directly to the IRS (i.e., do not use the depository method of tax payment described on page 7). The tax may be paid by check or money order, payable to the “United States Treasury.” To help ensure proper crediting, write the FSC's employer identification number (EIN), “Form 1120-FSC,” and the tax period to which the payment applies on the check or money order. Enclose the payment when Form 1120-FSC is filed with the Internal Revenue Service Center, Philadelphia, PA 19255.
FSCs that do maintain an office or place of business in the United States must pay the tax due using a qualified depositary. The two methods of depositing corporate taxes are discussed on page 7.

Electronic Deposit Requirement

The FSC must make electronic deposits of all depository taxes (such as employment tax, excise tax, and corporate income tax) using the Electronic Federal Tax Payment System (EFTPS) in 2004 if:

The total deposits of such taxes in 2002 were more than $200,000 or
The FSC was required to use EFTPS in 2003.

If the FSC is required to use EFTPS and fails to do so, it may be subject to a 10% penalty. If the FSC is not required to use EFTPS, it may participate voluntarily. To enroll in or get more information about EFTPS, call 1-800-555-4477 or 1-800-945-8400. To enroll online, visit www.eftps.gov.

Depositing on time. For EFTPS deposits to be made timely, the FSC must initiate the transaction at least 1 business day before the date the deposit is due.

Deposits With Form 8109

If the FSC does not use EFTPS, deposit FSC income tax payments (and estimated tax payments) with Form 8109, Federal Tax Deposit Coupon. If you do not have a preprinted Form 8109, use Form 8109-B to make deposits. You can get this form by calling 1-800-829-4933. Be sure to have your EIN ready when you call.

Do not send deposits directly to an IRS office; otherwise, the FSC may have to pay a penalty. Mail or deliver the completed Form 8109 with the payment to an authorized depositary (i.e., a commercial bank or other financial institution authorized to accept Federal tax deposits). Make checks or money orders payable to the depositary.

If the FSC prefers, it may mail the coupon and payment to: Financial Agent, Federal Tax Deposit Processing, P.O. Box 970030, St. Louis, MO 63197. Make the check or money order payable to “Financial Agent.”

To help ensure proper crediting, write the FSC's EIN, the tax period to which the deposit applies, and “Form 1120-FSC” on the check or money order. Be sure to darken the “1120” box on the coupon. Records of these deposits will be sent to the IRS.

For more information on deposits, see the instructions in the coupon booklet (Form 8109) and Pub. 583, Starting a Business and Keeping Records.

If the FSC maintains an office or place of business in the United States and it owes tax when it files Form 1120-FSC, do not include the payment with the tax return. Instead, mail or deliver the payment with Form 8109 to an authorized depositary, or use EFTPS, if applicable.

Estimated Tax Payments

Generally, the following rules apply to the FSC's payments of estimated tax.

The FSC must make installment payments of estimated tax if it expects its total tax for the year (less applicable credits) to be $500 or more.
The installments are due by the 15th day of the 4th, 6th, 9th, and 12th months of the tax year. If any date falls on a Saturday, Sunday, or legal holiday, the installment is due on the next regular business day.
Use Form 1120-W, Estimated Tax for Corporations, as a worksheet to compute estimated tax.
If the FSC maintains an office or place of business in the United States and it does not use EFTPS, use the deposit coupons (Forms 8109) to make deposits of estimated tax.
If the FSC does not maintain an office or place of business in the United States, it must pay the estimated tax due directly to the IRS.

For more information on estimated tax payments, including penalties that apply if the FSC fails to make required payments, see Line 3, Estimated tax penalty, on page 8.

Overpaid estimated tax. If the FSC overpaid estimated tax, it may be able to get a quick refund by filing Form 4466, Corporation Application for Quick Refund of Overpayment of Estimated Tax. The overpayment must be at least 10% of the FSC's expected income tax liability and at least $500. File Form 4466 after the end of the FSC's tax year, and no later than the 15th day of the third month after the end of the tax year. Form 4466 must be filed before the FSC files its tax return.

Interest and Penalties

Interest. Interest is charged on taxes paid late even if an extension of time to file is granted. Interest is also charged on penalties imposed for failure to file, negligence, fraud, substantial valuation misstatements, gross valuation misstatements, and substantial understatements of tax from the due date (including extensions) to the date of payment. The interest charge is figured at a rate determined under section 6621.

Penalty for late filing of return. A FSC that does not file its tax return by the due date, including extensions, may be penalized 5% of the unpaid tax for each month or part of a month the return is late, up to a maximum of 25% of the unpaid tax. The minimum penalty for a return that is over 60 days late is the smaller of the tax due or $100. The penalty will not be imposed if the FSC can show that the failure to file on time was due to reasonable cause. FSCs that file late must attach a statement explaining the reasonable cause.

Penalty for late payment of tax. A FSC that does not pay the tax when due generally may be penalized ½ of 1% of the unpaid tax for each month or part of a month the tax is not paid, up to a maximum of 25% of the unpaid tax. The penalty will not be imposed if the FSC can show that the failure to pay on time was due to reasonable cause.

Trust fund recovery penalty. This penalty may apply if certain income, social security, and Medicare taxes that must be collected or withheld are not collected or withheld, or these taxes are not paid. These taxes are generally reported on Forms 941 or 945 (see Other Forms, Schedules, and Statements That May Be Required on page 4). The trust fund recovery penalty may be imposed on all persons who are determined by the IRS to have been responsible for collecting, accounting for, and paying over these taxes, and who acted willfully in not doing so. The penalty is equal to the unpaid trust fund tax. See Pub. 15 (Circular E), Employer's Tax Guide, for details, including the definition of responsible persons.

Other penalties. Other penalties can be imposed for negligence, substantial understatement of tax, and fraud. See sections 6662 and 6663.

A FSC may also be subject to a penalty (under section 6686) of:

$100 for each failure to supply information, up to $25,000 during the calendar year.
$1,000 for not filing a return.

These penalties will not apply if the FSC can show that the failure to furnish the required information was due to reasonable cause.

General Instructions