Instructions for Form 1120S (2006)

Specific Instructions

This is archived information that pertains only to the 2006 Tax Year. If you
are looking for information for the current tax year, go to the Tax Prep Help Area.

Table of Contents

Period Covered

File the 2006 return for calendar year 2006 and fiscal years that begin in 2006 and end in 2007. For a fiscal or short tax year return, fill in the tax year space at the top of the form.

The 2006 Form 1120S can also be used if:

The corporation has a tax year of less than 12 months that begins and ends in 2007, and
The 2007 Form 1120S is not available at the time the corporation is required to file its return.

The corporation must show its 2007 tax year on the 2006 Form 1120S and take into account any tax law changes that are effective for tax years beginning after December 31, 2006.

Name and Address

Print or type the corporation's true name (as set forth in the charter or other legal document creating it), address, and EIN on the appropriate lines. Include the suite, room, or other unit number after the street address. If the post office does not deliver mail to the street address and the corporation has a P.O. box, show the box number instead.

If the corporation receives its mail in care of a third party (such as an accountant or an attorney), enter on the street address line “C/O” followed by the third party's name and street address or P.O. box.

If the corporation received a Form 1120S tax package, use the preprinted label. Cross out any errors and print the correct information on the label.

Item B. Business Code

See the Principal Business Activity Codes on pages 39 through 41 of these instructions.

Item C. Employer Identification Number (EIN)

Enter the corporation's EIN. If the corporation does not have an EIN, it must apply for one. An EIN can be applied for:

Online—Click on the EIN link at www.irs.gov/businesses/small. The EIN is issued immediately once the application information is validated.
By telephone at 1-800-829-4933 from 7:00 a.m. to 10:00 p.m. in the corporation's local time zone.
By mailing or faxing Form SS-4, Application for Employer Identification Number.

If the corporation has not received its EIN by the time the return is due, enter “Applied for” and the date you applied in the space for the EIN. For more details, see the Instructions for Form SS-4.

Item E. Total Assets

Enter the corporation's total assets (as determined by the accounting method regularly used in keeping the corporation's books and records) at the end of the tax year. If there were no assets at the end of the tax year, enter -0-.

If the corporation is required to complete Schedule L, enter total assets from Schedule L, line 15, column (d) on page 1, item E. If the S election terminated during the tax year, see the instructions for Schedule L on page 35 for special rules that may apply when figuring the corporation's year-end assets.

Item F. Initial Return, Final Return, Name Change, Address Change, or Amended Return

If this is the corporation's first return, check the “Initial return” box.
If this is the corporation's final return and it will no longer exist, check the “Final return” box. Also check the “Final K-1” box on each Schedule K-1.
If the corporation changed its name since it last filed a return, check the box for “Name change.” Generally, a corporation also must have amended its articles of incorporation and filed the amendment with the state in which it was incorporated.
If the corporation has changed its address since it last filed a return (including a change to an “in care of” address), check the box for “Address change.” If a change in address occurs after the return is filed, use Form 8822, Change of Address, to notify the IRS of the new address.
If this amends a previously filed return, check the box for “Amended return.” If Schedules K-1 are also being amended, check the “Amended K-1” box on each Schedule K-1.

Item H. Schedule M-3 Information

A corporation with total assets of $10 million or more on the last day of the tax year must complete Schedule M-3 (Form 1120S), Net Income (Loss) Reconciliation for S Corporations With Total Assets of $10 Million or More, instead of Schedule M-1. A corporation filing Form 1120S that is not required to file Schedule M-3 may voluntarily file Schedule M-3 instead of Schedule M-1.

If you are filing Schedule M-3, check the “Schedule M-3 required” box on line H at the top of page 1 of Form 1120S. See the Instructions for Schedule M-3 for more details.

Income

Report only trade or business activity income on lines 1a through 6. Do not report rental activity income or portfolio income on these lines. See Passive Activity Limitations beginning on page 6 for definitions of rental income and portfolio income. Rental activity income and portfolio income are reported on Schedules K and K-1. Rental real estate activities are also reported on Form 8825.

Tax-exempt income. Do not include any tax-exempt income on lines 1a through 5. A corporation that receives any tax-exempt income other than interest, or holds any property or engages in any activity that produces tax-exempt income, reports this income on line 16b of Schedule K and in box 16 of Schedule K-1 using code B.

Report tax-exempt interest income, including exempt-interest dividends received as a shareholder in a mutual fund or other regulated investment company, on line 16a of Schedule K and in box 16 of Schedule K-1 using code A.

See Deductions on page 13 for information on how to report expenses related to tax-exempt income.

Cancelled debt exclusion. If the corporation has had debt discharged resulting from a title 11 bankruptcy proceeding or while insolvent, see Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment), and Pub. 908, Bankruptcy Tax Guide.

Line 1. Gross Receipts or Sales

Enter gross receipts or sales from all business operations except those that must be reported on lines 4 and 5.

In general, advance payments are reported in the year of receipt. To report income from long-term contracts, see section 460. For special rules for reporting certain advance payments for goods and long-term contracts, see Regulations section 1.451-5. For permissible methods for reporting advance payments for services and certain goods by an accrual method corporation, see Rev. Proc. 2004-34, 2004-22 I.R.B. 991.

Installment sales. Generally, the installment method cannot be used for dealer dispositions of property. A “dealer disposition” is any disposition of: (a) personal property by a person who regularly sells or otherwise disposes of personal property of the same type on the installment plan or (b) real property held for sale to customers in the ordinary course of the taxpayer's trade or business.

These restrictions on using the installment method do not apply to dispositions of property used or produced in a farming business or sales of timeshares and residential lots for which the corporation elects to pay interest under section 453(l)(3).

For sales of timeshares and residential lots reported under the installment method, each shareholder's income tax is increased by the shareholder's pro rata share of the interest payable under section 453(l)(3).

Enter on line 1a the gross profit on collections from installment sales for any of the following.

Dealer dispositions of property before March 1, 1986.
Dispositions of property used or produced in the trade or business of farming.
Certain dispositions of timeshares and residential lots reported under the installment method.

Attach a statement showing the following information for the current and the 3 preceding years: (a) gross sales, (b) cost of goods sold, (c) gross profits, (d) percentage of gross profits to gross sales, (e) amount collected, and (f) gross profit on the amount collected.

Line 2. Cost of Goods Sold

See the instructions for Schedule A on page 18.

Line 4. Net Gain (Loss) From Form 4797

Include only ordinary gains or losses from the sale, exchange, or involuntary conversion of assets used in a trade or business activity. Ordinary gains or losses from the sale, exchange, or involuntary conversion of rental activity assets are reported separately on line 19 of Form 8825 or line 3 of Schedule K and box 3 of Schedule K-1, generally as a part of the net income (loss) from the rental activity.

A corporation that is a partner in a partnership must include on Form 4797, Sales of Business Property, its share of ordinary gains (losses) from sales, exchanges, or involuntary conversions (other than casualties or thefts) of the partnership's trade or business assets.

Corporations should not use Form 4797 to report the sale or other disposition of property if a section 179 expense deduction was previously passed through to any of its shareholders for that property. Instead, report it in box 17 of Schedule K-1 using code K. See the instructions on page 33 for Dispositions of property with section 179 deductions (code K), for details.

Line 5. Other Income (Loss)

Enter any other trade or business income (loss) not included on lines 1a through 4. List the type and amount of income on an attached statement.

Examples of other income include the following.

Interest income derived in the ordinary course of the corporation's trade or business, such as interest charged on receivable balances. See Temporary Regulations section 1.469-2T(c)(3).
Recoveries of bad debts deducted in prior years under the specific charge-off method.
Taxable income from insurance proceeds.
The amount included in income from line 4 of Form 6478, Credit for Alcohol Used as Fuel.
The amount included in income from line 8 of Form 8864, Biodiesel and Renewable Diesel Fuels Credit.
The recapture amount under section 280F if the business use of listed property drops to 50% or less. To figure the recapture amount, complete Part IV of Form 4797.
Any recapture amount under section 179A for certain clean-fuel vehicle property (or clean-fuel vehicle refueling property) that ceases to qualify. See Regulations section 1.179A-1 for details.
All section 481 income adjustments resulting from changes in accounting methods. Show the computation of the section 481 adjustments on an attached statement.

Do not include items requiring separate computations by shareholders that must be reported on Schedules K and K-1. See the instructions for Schedules K and K-1 later in these instructions.

Ordinary Income (Loss) From a Partnership, Estate, or Trust

Enter the ordinary income (loss) shown on Schedule K-1 (Form 1065) or Schedule K-1 (Form 1041), or other ordinary income (loss) from a foreign partnership, estate, or trust. Show the partnership's, estate's, or trust's name, address, and EIN on a separate statement attached to this return. If the amount entered is from more than one source, identify the amount from each source.

Do not include portfolio income or rental activity income (loss) from a partnership, estate, or trust on this line. Instead, report these amounts on Schedules K and K-1, or on line 20a of Form 8825 if the amount is from a rental real estate activity.

Ordinary income or loss from a partnership that is a publicly traded partnership is not reported on this line. Instead, report the amount separately on line 10 of Schedule K and in box 10 of Schedule K-1 using code E.

Treat shares of other items separately reported on Schedule K-1 issued by the other entity as if the items were realized or incurred by this corporation.

If there is a loss from a partnership, the amount of the loss that may be claimed is subject to the at-risk and basis limitations as appropriate.

If the tax year of the S corporation does not coincide with the tax year of the partnership, estate, or trust, include the ordinary income (loss) from the other entity in the tax year in which the other entity's tax year ends.

Deductions

Report only trade or business activity deductions on lines 7 through 19.

Do not report the following expenses on lines 7 through 19.

Rental activity expenses. Report these expenses on Form 8825 or line 3b of Schedule K.
Deductions allocable to portfolio income. Report these deductions on line 12d of Schedule K and in box 12 of Schedule K-1 using code H, J, or K.
Nondeductible expenses (for example, expenses connected with the production of tax-exempt income). Report nondeductible expenses on line 16c of Schedule K and in box 16 of Schedule K-1 using code C.
Qualified expenditures to which an election under section 59(e) may apply. The instructions for line 12c of Schedule K and for Schedule K-1, box 12, code I, explain how to report these amounts.
Items the corporation must state separately that require separate computations by the shareholders. Examples include expenses incurred for the production of income instead of in a trade or business, charitable contributions, foreign taxes paid or accrued, intangible drilling and development costs, soil and water conservation expenditures, amortizable basis of reforestation expenditures, and exploration expenditures. The pro rata shares of these expenses are reported separately to each shareholder on Schedule K-1.

Limitations on Deductions

Section 263A uniform capitalization rules. The uniform capitalization rules of section 263A generally require corporations to capitalize, or include in inventory, certain costs incurred in connection with the following.

The production of real property and tangible personal property held in inventory or held for sale in the ordinary course of business.
Real property or personal property (tangible and intangible) acquired for resale.
The production of real property and tangible personal property by a corporation for use in its trade or business or in an activity engaged in for profit.

Tangible personal property produced by a corporation includes a film, sound recording, videotape, book, or similar property.

The costs required to be capitalized under section 263A are not deductible until the property to which the costs relate is sold, used, or otherwise disposed of by the corporation.

Exceptions. Section 263A does not apply to the following.

Inventoriable items accounted for in the same manner as materials and supplies that are not incidental. See Schedule A. Cost of Goods Sold on page 18 for details.
Personal property acquired for resale if the corporation's average annual gross receipts for the 3 prior tax years were $10 million or less.
Timber.
Most property produced under a long-term contract.
Certain property produced in a farming business. See Special rules for certain corporations engaged in farming on page 14.
Geological and geophysical costs amortized under section 167(h).

The corporation must report the following costs separately to the shareholders for purposes of determinations under section 59(e).

Research and experimental costs under section 174.
Intangible drilling costs for oil, gas, and geothermal property.
Mining exploration and development costs.

Indirect costs. Corporations subject to the uniform capitalization rules are required to capitalize not only direct costs but an allocable part of most indirect costs (including taxes) that benefit the assets produced or acquired for resale, or are incurred because of the performance of production or resale activities.

For inventory, some of the indirect costs that must be capitalized are:

Administration expenses;
Taxes;
Depreciation;
Insurance;
Compensation paid to officers attributable to services;
Rework labor; and
Contributions to pension, stock bonus, and certain profit-sharing, annuity, or deferred compensation plans.

Regulations section 1.263A-1(e)(3) specifies other indirect costs that relate to production or resale activities that must be capitalized and those that may be currently deductible.

Interest expense paid or incurred during the production period of designated property must be capitalized and is governed by special rules. For more details, see Regulations sections 1.263A-8 through 1.263A-15.

For more details on the uniform capitalization rules, see Regulations sections 1.263A-1 through 1.263A-3.

Special rules for certain corporations engaged in farming. For S corporations not required to use the accrual method of accounting, the rules of section 263A do not apply to expenses of raising any:

Animal or
Plant that has a preproductive period of 2 years or less.

Shareholders of S corporations not required to use the accrual method of accounting may elect to currently deduct the preproductive period expenses of certain plants that have a preproductive period of more than 2 years. Because each shareholder makes the election to deduct these expenses, the corporation should not capitalize them. Instead, the corporation should report the expenses separately on line 12d of Schedule K and report each shareholder's pro rata share in box 12 of Schedule K-1 using code L.

See Uniform Capitalization Rules in chapter 6 of Pub. 225, Farmer's Tax Guide, sections 263A(d) and (e), and Regulations section 1.263A-4 for definitions and other details.

Transactions between related taxpayers. Generally, an accrual basis S corporation can deduct business expenses and interest owed to a related party (including any shareholder) only in the tax year of the corporation that includes the day on which the payment is includible in the income of the related party. See section 267 for details.

Section 291 limitations. If the S corporation was a C corporation for any of the 3 immediately preceding years, the corporation may be required to adjust deductions for depletion of iron ore and coal, and the amortizable basis of pollution control facilities. If this applies, see section 291 to figure the adjustment.

Business start-up and organizational costs. Business start-up and organizational costs must be capitalized unless an election is made to deduct or amortize them. The corporation can elect to amortize costs paid or incurred before October 23, 2004, over a period of 60 months or more. For costs paid or incurred after October 22, 2004, the following rules apply separately to each category of costs.

The corporation can elect to deduct up to $5,000 of such costs for the year the corporation begins business operations.
The $5,000 deduction is reduced (but not below zero) by the amount the total costs exceed $50,000. If the total costs are $55,000 or more, the deduction is reduced to zero.
If the election is made, any costs that are not deducted must be amortized ratably over a 180-month period.

In all cases, the amortization period begins the month the corporation begins business operations. For more details on the election, see Pub. 535.

Attach any statement required by Regulations sections 1.195-1(b) or 1.248-1(c). Report the deductible amount of these costs and any amortization on line 19. For amortization that begins during the 2006 tax year, complete and attach Form 4562.

Reducing certain expenses for which credits are allowable. If the corporation claims a credit on any of the following forms, it may need to reduce the otherwise allowable deductions for expenses used to figure the credit.

Form 5884, Work Opportunity Credit.
Form 5884-A, Credits for Employers Affected by Hurricane Katrina, Rita, or Wilma.
Form 6765, Credit for Increasing Research Activities.
Form 8820, Orphan Drug Credit.
Form 8826, Disabled Access Credit.
Form 8844, Empowerment Zone and Renewal Community Employment Credit.
Form 8845, Indian Employment Credit.
Form 8846, Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips.
Form 8861, Welfare-to-Work Credit.
Form 8881, Credit for Small Employer Pension Plan Startup Costs.
Form 8882, Credit for Employer-Provided Childcare Facilities and Services.
Form 8896, Low Sulfur Diesel Fuel Production Credit.
Form 8923, Mine Rescue Team Training Credit.

If the corporation has any of these credits, figure each current year credit before figuring the deduction for expenses on which the credit is based. See the instructions for the form used to figure the credit for details.

Line 7. Compensation of Officers and Line 8. Salaries and Wages

Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.

Enter on line 7 the total compensation of all officers paid or incurred in the trade or business activities of the corporation. The corporation determines who is an officer under the laws of the state where it is incorporated.

Enter on line 8 the total salaries and wages paid or incurred to employees (other than officers) during the tax year.

If the corporation claims a credit for any wages paid or incurred, it may need to reduce the amounts on lines 7 and 8. See Reducing certain expenses for which credits are allowable on this page for details.

Do not include salaries and wages reported elsewhere on the return, such as amounts included in cost of goods sold, elective contributions to a section 401(k) cash or deferred arrangement, or amounts contributed under a salary reduction SEP agreement or a SIMPLE IRA plan.

Include fringe benefit expenditures made on behalf of officers and employees owning more than 2% of the corporation's stock. Also report these fringe benefits as wages in box 1 of Form W-2. Do not include amounts paid or incurred for fringe benefits of officers and employees owning 2% or less of the corporation's stock. These amounts are reported on line 18. See the instructions for that line for information on the types of expenditures that are treated as fringe benefits and for the stock ownership rules.

Report amounts paid for health insurance coverage for a more than 2% shareholder (including that shareholder's spouse and dependents) as an information item in box 14 of that shareholder's Form W-2. A more-than-2% shareholder may be allowed to deduct such amounts on Form 1040, line 29.

If a shareholder or a member of the family of one or more shareholders of the corporation renders services or furnishes capital to the corporation for which reasonable compensation is not paid, the IRS may make adjustments in the items taken into account by such individuals to reflect the value of such services or capital. See section 1366(e).

Line 9. Repairs and Maintenance

Enter the cost of incidental repairs and maintenance not claimed elsewhere on the return, such as labor and supplies, that do not add to the value of the property or appreciably prolong its life. The corporation can deduct these repairs only to the extent they relate to a trade or business activity. New buildings, machinery, or permanent improvements that increase the value of the property are not deductible. They must be depreciated or amortized.

Line 10. Bad Debts

Enter the total debts that became worthless in whole or in part during the tax year, but only to the extent such debts relate to a trade or business activity. Report deductible nonbusiness bad debts as a short-term capital loss on Schedule D (Form 1120S), Capital Gains and Losses and Built-In Gains. A cash method taxpayer cannot claim a bad debt deduction unless the amount was previously included in income.

Line 11. Rents

Enter rent paid on business property used in a trade or business activity. Do not deduct rent for a dwelling unit occupied by any shareholder for personal use.

If the corporation rented or leased a vehicle, enter the total annual rent or lease expense paid or incurred in the trade or business activities of the corporation during the tax year. Also complete Part V of Form 4562, Depreciation and Amortization. If the corporation leased a vehicle for a term of 30 days or more, the deduction for vehicle lease expense may have to be reduced by an amount called the inclusion amount. The corporation may have an inclusion amount if:

The lease term began:	And the vehicle's FMV on the first day of the lease exceeded:
After 12/31/04 but before 1/1/07	$15,200
After 12/31/03 but before 1/1/05	$17,500
After 12/31/02 but before 1/1/04	$18,000
After 12/31/98 but before 1/1/03	$15,500
If the lease term began before January 1, 1999, see Pub. 463, Travel, Entertainment, Gift, and Car Expenses, to find out if the corporation has an inclusion amount. The inclusion amount for lease terms beginning in 2007 will be published in the Internal Revenue Bulletin in early 2007.

See Pub. 463 for instructions on figuring the inclusion amount.

Line 12. Taxes and Licenses

Enter taxes and licenses paid or incurred in the trade or business activities of the corporation, unless they are reflected elsewhere on the return. Federal import duties and federal excise and stamp taxes are deductible only if paid or incurred in carrying on the trade or business of the corporation.

Do not deduct the following taxes on line 12.

Federal income taxes (except for the portion of built-in gains tax allocable to ordinary income), or taxes reported elsewhere on the return.
Section 901 foreign taxes. Report these taxes on line 14l of Schedule K and in box 14 of Schedule K-1 using codes L and M.
Taxes allocable to a rental activity. Taxes allocable to a rental real estate activity are reported on Form 8825. Taxes allocable to a rental activity other than a rental real estate activity are reported on line 3b of Schedule K.
Taxes allocable to portfolio income. Report these taxes on line 12d of Schedule K and in box 12 of Schedule K-1 using code J.
Taxes paid or incurred for the production or collection of income, or for the management, conservation, or maintenance of property held to produce income. Report these taxes separately on line 12d of Schedule K and in box 12 of Schedule K-1 using code R.

See section 263A(a) for rules on capitalization of allocable costs (including taxes) for any property.

Taxes not imposed on the corporation.
Taxes, including state or local sales taxes, that are paid or incurred in connection with an acquisition or disposition of property (these taxes must be treated as a part of the cost of the acquired property or, in the case of a disposition, as a reduction in the amount realized on the disposition).
Taxes assessed against local benefits that increase the value of the property assessed (such as for paving, etc.).

See section 164(d) for apportionment of taxes on real property between seller and purchaser.

Line 13. Interest

Include only interest incurred in the trade or business activities of the corporation that is not claimed elsewhere on the return.

Do not include interest expense:

On debt used to purchase rental property or debt used in a rental activity. Interest allocable to a rental real estate activity is reported on Form 8825 and is used in arriving at net income (loss) from rental real estate activities on line 2 of Schedule K and in box 2 of Schedule K-1. Interest allocable to a rental activity other than a rental real estate activity is included on line 3b of Schedule K and is used in arriving at net income (loss) from a rental activity (other than a rental real estate activity). This net amount is reported on line 3c of Schedule K and in box 3 of Schedule K-1.
On debt used to buy property held for investment. Interest that is clearly and directly allocable to interest, dividend, royalty, or annuity income not derived in the ordinary course of a trade or business is reported on line 12b of Schedule K and in box 12 of Schedule K-1 using code G. See the instructions for line 12b of Schedule K, for box 12, code G of Schedule K-1, and Form 4952, Investment Interest Expense Deduction, for more information on investment property.
On debt proceeds allocated to distributions made to shareholders during the tax year. Instead, report such interest on line 12d of Schedule K and in box 12 of Schedule K-1 using code R. To determine the amount to allocate to distributions to shareholders, see Notice 89-35, 1989-1 C.B. 675.
On debt required to be allocated to the production of designated property. Designated property includes real property, personal property that has a class life of 20 years or more, and other tangible property requiring more than 2 years (1 year in the case of property with a cost of more than $1 million) to produce or construct. Interest allocable to designated property produced by a corporation for its own use or for sale must be capitalized.
In addition, a corporation must also capitalize any interest on debt allocable to an asset used to produce designated property. A shareholder may have to capitalize interest that the shareholder incurs during the tax year for the S corporation's production expenditures. Similarly, interest incurred by an S corporation may have to be capitalized by a shareholder for the shareholder's own production expenditures. The information required by the shareholder to properly capitalize interest for this purpose must be provided by the corporation on an attachment for box 17 of Schedule K-1 using code P. See section 263A(f) and Regulations sections 1.263A-8 through 1.263A-15.

Special rules apply to:

Allocating interest expense among activities so that the limitations on passive activity losses, investment interest, and personal interest can be properly figured. Generally, interest expense is allocated in the same manner as debt is allocated. Debt is allocated by tracing disbursements of the debt proceeds to specific expenditures. Temporary Regulations section 1.163-8T gives rules for tracing debt proceeds to expenditures.
Prepaid interest, which generally can only be deducted over the period to which the prepayment applies. See section 461(g) for details.
Interest which is allocable to unborrowed policy cash values of life insurance, endowment, or annuity contracts issued after June 8, 1997. See section 264(f). Attach a statement showing the computation of the deduction.

Line 14. Depreciation

Enter the depreciation claimed on assets used in a trade or business activity less any depreciation reported elsewhere on the return (for example, on Schedule A). See the Instructions for Form 4562 or Pub. 946, How To Depreciate Property, to figure the amount of depreciation to enter on this line.

Complete and attach Form 4562 only if the corporation placed property in service during the tax year or claims depreciation on any car or other listed property. There is different treatment for property located in a GO Zone. See the instructions for Form 4562 for details.

Do not include any section 179 expense deduction on this line. This amount is not deducted by the corporation. Instead, it is passed through to the shareholders in box 11 of Schedule K-1.

Line 15. Depletion

If the corporation claims a deduction for timber depletion, complete and attach Form T (Timber), Forest Activities Schedule.

Do not deduct depletion for oil and gas properties. Each shareholder figures depletion on oil and gas properties. See the instructions for Schedule K-1, box 17, code R, for the information on oil and gas depletion that must be supplied to the shareholders by the corporation.

Line 17. Pension, Profit-Sharing, etc., Plans

Enter the deductible contributions not claimed elsewhere on the return made by the corporation for its employees under a qualified pension, profit-sharing, annuity, or simplified employee pension (SEP) or SIMPLE plan, or any other deferred compensation plan.

If the corporation contributes to an individual retirement arrangement (IRA) for employees, include the contribution in salaries and wages on page 1, line 8, or Schedule A, line 3, and not on line 17.

Employers who maintain a pension, profit-sharing, or other funded deferred compensation plan, whether or not the plan is qualified under the Internal Revenue Code and whether or not a deduction is claimed for the current tax year, generally must file the applicable form listed below.

Form 5500, Annual Return/Report of Employee Benefit Plan. File this form for a plan that is not a one-participant plan.
Form 5500-EZ, Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan. File this form for a plan that only covers the owner (or the owner and his or her spouse) but only if the owner (or the owner and his or her spouse) owns the entire business.

There are penalties for not filing these forms on time and for overstating the pension plan deduction. See sections 6652(e) and 6662(f).

Line 18. Employee Benefit Programs

Enter amounts for fringe benefits paid or incurred on behalf of employees owning 2% or less of the corporation's stock. These fringe benefits include (a) employer contributions to certain accident and health plans, (b) the cost of up to $50,000 of group-term life insurance on an employee's life, and (c) meals and lodging furnished for the employer's convenience.

Do not deduct amounts that are an incidental part of a pension, profit-sharing, etc., plan included on line 17 or amounts reported elsewhere on the return.

Report amounts for fringe benefits paid on behalf of employees owning more than 2% of the corporate stock on line 7 or 8, whichever applies. An employee is considered to own more than 2% of the corporation's stock if that person owns on any day during the tax year more than 2% of the outstanding stock of the corporation or stock possessing more than 2% of the combined voting power of all stock of the corporation. See section 318 for attribution rules.

Line 19. Other Deductions

Enter the total allowable trade or business deductions that are not deductible elsewhere on page 1 of Form 1120S. Attach a statement listing by type and amount each deduction included on this line.

Examples of other deductions include the following.

Amortization. See Part VI of Form 4562.
Certain business start-up and organizational costs the corporation elects to deduct. See page 14.
Insurance premiums.
Legal and professional fees.
Supplies used and consumed in the business.
Travel, meal and entertainment expenses. Special rules apply (discussed below).
Utilities.
Deduction for certain energy efficient commercial building property. See section 179D and Notice 2006-52, 2006-26 I.R.B. 1175.
Any negative net section 481(a) adjustment.

Do not deduct the following on line 19.

Items that must be reported separately on Schedules K and K-1.
Fines or penalties paid to a government for violating any law. Report these expenses on Schedule K, line 16c.
Expenses allocable to tax-exempt income. Report these expenses on Schedule K, line 16c.

Special Rules

Commercial revitalization deduction. If the corporation constructs, purchases, or substantially rehabilitates a qualified building in a renewal community, it may qualify for a deduction of either (a) 50% of qualified capital expenditures in the year the building is placed in service or (b) amortization of 100% of the qualified capital expenditures over a 120-month period beginning with the month the building is placed in service. If the corporation elects to amortize these expenditures, complete and attach Form 4562. To qualify, the building must be nonresidential (as defined in section 168(e)(2)) and placed in service by the corporation. The corporation must be the original user of the building unless it is substantially rehabilitated. The qualified expenditures cannot exceed the lesser of $10 million or the amount allocated to the building by the commercial revitalization agency of the state in which the building is located. Any remaining expenditures are depreciated over the regular depreciation recovery period. See Pub. 954, Tax Incentives for Distressed Communities, and section 1400I for details.

Rental real estate. Do not report this deduction on line 19 if the building is placed in service as rental real estate. A commercial revitalization deduction for rental real estate is not deducted by the corporation but is passed through to the shareholders in box 12 of Schedule K-1 using code M.

Travel, meals, and entertainment. Subject to limitations and restrictions discussed below, a corporation can deduct ordinary and necessary travel, meals, and entertainment expenses paid or incurred in its trade or business. Also, special rules apply to deductions for gifts, skybox rentals, luxury water travel, convention expenses, and entertainment tickets. See section 274 and Pub. 463 for details.

Travel. The corporation cannot deduct travel expenses of any individual accompanying a corporate officer or employee, including a spouse or dependent of the officer or employee, unless:

That individual is an employee of the corporation, and
His or her travel is for a bona fide business purpose and would otherwise be deductible by that individual.

Meals and entertainment. Generally, the corporation can deduct only 50% of the amount otherwise allowable for meals and entertainment expenses paid or incurred in its trade or business. In addition (subject to exceptions under section 274(k)(2)):

Meals must not be lavish or extravagant;
A bona fide business discussion must occur during, immediately before, or immediately after the meal; and
An employee of the corporation must be present at the meal.

See section 274(n)(3) for a special rule that applies to expenses for meals consumed by individuals subject to the hours of service limits of the Department of Transportation.

Membership dues. The corporation can deduct amounts paid or incurred for membership dues in civic or public service organizations, professional organizations (such as bar and medical associations), business leagues, trade associations, chambers of commerce, boards of trade, and real estate boards. However, no deduction is allowed if a principal purpose of the organization is to entertain, or provide entertainment facilities for, members or their guests. In addition, corporations cannot deduct membership dues in any club organized for business, pleasure, recreation, or other social purpose. This includes country clubs, golf and athletic clubs, airline and hotel clubs, and clubs operated to provide meals under conditions favorable to business discussion.

Entertainment facilities. The corporation cannot deduct an expense paid or incurred for a facility (such as a yacht or hunting lodge) used for an activity usually considered entertainment, amusement, or recreation.

Amounts treated as compensation. The corporation may be able to deduct otherwise nondeductible entertainment, amusement, or recreation expenses if the amounts are treated as compensation to the recipient and reported on Form W-2 for an employee or on Form 1099-MISC for an independent contractor.

However, if the recipient is an officer, director, or beneficial owner (directly or indirectly) of more than 10% of the corporation's stock, the deductible expense is limited. See section 274(e)(2) and Notice 2005-45, 2005-24 I.R.B. 1228.

Lobbying expenses. Generally, lobbying expenses are not deductible. Report nondeductible expenses on Schedule K, line 16c. These expenses include:

Amounts paid or incurred in connection with influencing federal or state legislation (but not local legislation) or
Amounts paid or incurred in connection with any communication with certain federal executive branch officials in an attempt to influence the official actions or positions of the officials. See Regulations section 1.162-29 for the definition of “influencing legislation.”

Dues and other similar amounts paid to certain tax-exempt organizations may not be deductible. See section 162(e)(3). If certain in-house lobbying expenditures do not exceed $2,000, they are deductible. For information on contributions to charitable organizations that conduct lobbying activities, see section 170(f)(9).

Certain corporations engaged in farming. Section 464(f) limits the deduction for certain expenditures of S corporations engaged in farming if they use the cash method of accounting, and their prepaid farm supplies are more than 50% of other deductible farming expenses.

Prepaid farm supplies include expenses for feed, seed, fertilizer, and similar farm supplies not used or consumed during the year. They also include the cost of poultry that would be allowable as a deduction in a later tax year if the corporation were to (a) capitalize the cost of poultry bought for use in its farm business and deduct it ratably over the lesser of 12 months or the useful life of the poultry and (b) deduct the cost of poultry bought for resale in the year it sells or otherwise disposes of it.

If the limit applies, the corporation can deduct prepaid farm supplies that do not exceed 50% of its other deductible farm expenses in the year of payment. The excess is deductible only in the year the corporation uses or consumes the supplies (other than poultry, which is deductible as explained above). For exceptions and more details on these rules, see Pub. 225.

This image is too large to be displayed in the current screen. Please click the link to view the image.

Excess net passive income tax worksheet

Reforestation expenditures. If the corporation made an election to deduct a portion of its reforestation expenditures on line 12d of Schedule K, it must amortize over an 84-month period the portion of these expenditures in excess of the amount deducted on Schedule K (see section 194). Deduct on line 19 only the amortization of these excess reforestation expenditures. See Reforestation expense deduction (code N) on page 27.

Do not deduct amortization of reforestation expenditures paid or incurred before October 23, 2004. If the corporation elected to amortize these expenditures, report the amortizable basis on line 17d of Schedule K. See Amortization of reforestation costs (code S) on page 34 for details.

Line 21. Ordinary Business Income (Loss)

Enter this income or loss on line 1 of Schedule K. Line 21 income is not used in figuring the excess net passive income or built-in gains taxes. See the instructions for line 22a for figuring taxable income for purposes of these taxes.

Tax and Payments

Line 22a. Excess Net Passive Income and LIFO Recapture Tax

These taxes can apply if the corporation was previously a C corporation or if the corporation engaged in a tax-free reorganization with a C corporation.

Excess net passive income tax. If the corporation has accumulated earnings and profits (AE&P) at the close of its tax year, has passive investment income for the tax year that is in excess of 25% of gross receipts, and has taxable income at year-end, the corporation must pay a tax on the excess net passive income. Complete lines 1 through 3 and line 9 of the worksheet on page 17 to make this determination. If line 2 is greater than line 3 and the corporation has taxable income (see instructions for line 9 of worksheet), it must pay the tax. Complete a separate schedule using the format of lines 1 through 11 of the worksheet to figure the tax. Enter the tax on line 22a, page 1, Form 1120S, and attach the computation schedule to Form 1120S.

Reduce each item of passive income passed through to shareholders by its portion of any excess net passive income tax reported on line 22a. See section 1366(f)(3).

LIFO recapture tax. The corporation may be liable for the additional tax due to LIFO recapture under Regulations section 1.1363-2 if:

The corporation used the LIFO inventory pricing method for its last tax year as a C corporation, or
A C corporation transferred LIFO inventory to the corporation in a nonrecognition transaction in which those assets were transferred basis property.

The additional tax due to LIFO recapture is figured for the corporation's last tax year as a C corporation or for the tax year of the transfer, whichever applies. See the Instructions for Forms 1120 and 1120-A to figure the tax.

The tax is paid in four equal installments. The C corporation must pay the first installment by the due date (not including extensions) of Form 1120 for the corporation's last tax year as a C corporation or for the tax year of the transfer, whichever applies. The S corporation must pay each of the remaining installments by the due date (not including extensions) of Form 1120S for the 3 succeeding tax years. Include this year's installment in the total amount to be entered on line 22a. To the left of the total on line 22a, enter the installment amount and “LIFO tax.”

Line 22b. Tax From Schedule D (Form 1120S)

Enter the built-in gains tax from line 21 of Part III of Schedule D. See the instructions for Part III of Schedule D to determine if the corporation is liable for the tax.

Line 22c

Include the following in the total for line 22c.

Investment credit recapture tax. The corporation is liable for investment credit recapture attributable to credits allowed for tax years for which the corporation was not an S corporation. Figure the corporation's investment credit recapture tax by completing Form 4255, Recapture of Investment Credit.

To the left of the line 22c total, enter the amount of recapture tax and “Tax From Form 4255.” Attach Form 4255 to Form 1120S.

Interest due under the look-back method for completed long-term contracts. If the corporation owes this interest, attach Form 8697. To the left of the total on line 22c, enter the amount owed and “From Form 8697.”

Interest due under the look-back method for property depreciated under the income forecast method. If the corporation owes this interest, attach Form 8866. To the left of the total on line 22c, enter the amount owed and “From Form 8866.”

Line 23d. Credit for Federal Telephone Excise Tax Paid

If the corporation was billed after February 28, 2003, and before August 1, 2006, for the federal telephone excise tax on long distance or bundled service, the corporation may be able to request a credit for the tax paid. The corporation had bundled service if its local and long distance service was provided under a plan that does not separately state the charge for local service. The corporation cannot request the credit if it has already received a credit or refund from its service provider. If the corporation requests the credit, it cannot ask its service provider for a credit or refund and must withdraw any request previously submitted to its provider.

The corporation can request the credit by attaching Form 8913, Credit for Federal Telephone Excise Tax Paid, showing the actual amount the corporation paid. The corporation also may be able to request the credit based on an estimate of the amount paid. See Form 8913 for details. In either case, the corporation must keep records to substantiate the amount of the credit requested.

Line 23e

If the corporation is the beneficiary of a trust, and the trust makes a section 643(g) election to credit its estimated tax payments to its beneficiaries, include the corporation's share of the payment in the total for line 23e. Enter “T” and the amount on the dotted line to the left of the entry space.

Line 24. Estimated Tax Penalty

If Form 2220 is attached, check the box on line 24 and enter the amount of any penalty on this line.

Line 27

Direct deposit of refund. If the corporation wants its refund directly deposited into its checking or savings account at any U.S. bank or other financial institution instead of having a check sent to the corporation, complete Form 8050 and attach it to the corporation's return. However, the corporation cannot have its refund from an amended return directly deposited.

Schedule A. Cost of Goods Sold

Generally, inventories are required at the beginning and end of each tax year if the production, purchase, or sale of merchandise is an income-producing factor. See Regulations section 1.471-1.

However, if the corporation is a qualifying taxpayer or a qualifying small business taxpayer, it can adopt or change its accounting method to account for inventoriable items in the same manner as materials and supplies that are not incidental (unless its business is a tax shelter (as defined in section 448(d)(3))).

A qualifying taxpayer is a taxpayer that, for each prior tax year ending after December 16, 1998, has average annual gross receipts of $1 million or less for the 3-tax-year period ending with that prior tax year.

A qualifying small business taxpayer is a taxpayer (a) that, for each prior tax year ending on or after December 31, 2000, has average annual gross receipts of $10 million or less for the 3-tax-year period ending with that prior tax year and (b) whose principal business activity is not an ineligible activity.

Under this accounting method, inventory costs for raw materials purchased for use in producing finished goods and merchandise purchased for resale are deductible in the year the finished goods or merchandise are sold (but not before the year the corporation paid for the raw materials or merchandise, if it is also using the cash method). For additional guidance on this method of accounting for inventoriable items, see Pub. 538 and the Instructions for Form 3115.

Enter amounts paid for all raw materials and merchandise during the tax year on line 2. The amount the corporation can deduct for the tax year is figured on line 8.

All filers that have not elected to treat inventoriable items as materials and supplies that are not incidental should see Section 263A uniform capitalization rules on page 13 before completing Schedule A.

Line 1. Inventory at Beginning of Year

If the corporation is changing its method of accounting for the current tax year, it must refigure last year's closing inventory using its new method of accounting and enter the result on line 1. If there is a difference between last year's closing inventory and the refigured amount, attach an explanation and take it into account when figuring the corporation's section 481(a) adjustment.

Line 4. Additional Section 263A Costs

An entry is required on this line only for corporations that have elected a simplified method of accounting.

For corporations that have elected the simplified production method, additional section 263A costs are generally those costs, other than interest, that were not capitalized under the corporation's method of accounting immediately prior to the effective date of section 263A but are now required to be capitalized under section 263A. For details, see Regulations section 1.263A-2(b).

For corporations that have elected the simplified resale method, additional section 263A costs are generally those costs incurred with respect to the following categories.

Off-site storage or warehousing.
Purchasing.
Handling, such as processing, assembling, repackaging, and transporting.
General and administrative costs (mixed service costs).

For details, see Regulations section 1.263A-3(d).

Enter on line 4 the balance of section 263A costs paid or incurred during the tax year not includible on lines 2, 3, and 5.

Line 5. Other Costs

Enter on line 5 any costs paid or incurred during the tax year not entered on lines 2 through 4.

Line 7. Inventory at End of Year

See Regulations sections 1.263A-1 through 1.263A-3 for details on figuring the amount of additional section 263A costs to be included in ending inventory. If the corporation accounts for inventoriable items in the same manner as materials and supplies that are not incidental, enter on line 7 the portion of its raw materials and merchandise purchased for resale that is included on line 6 and was not sold during the year.

Lines 9a Through 9f. Inventory Valuation Methods

Inventories can be valued at:

Cost,
Cost or market value (whichever is lower), or
Any other method approved by the IRS that conforms to the requirements of the applicable regulations cited below.

However, if the corporation is using the cash method of accounting, it is required to use cost.

Corporations that account for inventoriable items in the same manner as materials and supplies that are not incidental can currently deduct expenditures for direct labor and all indirect costs that would otherwise be included in inventory costs.

The average cost (rolling average) method of valuing inventories generally does not conform to the requirements of the regulations. See Rev. Rul. 71-234, 1971-1 C.B. 148.

Corporations that use erroneous valuation methods must change to a method permitted for federal income tax purposes. Use Form 3115 to make this change.

On line 9a, check the method(s) used for valuing inventories. Under lower of cost or market, the term “market” (for normal goods) means the current bid price prevailing on the inventory valuation date for the particular merchandise in the volume usually purchased by the taxpayer. For a manufacturer, market applies to the basic elements of cost—raw materials, labor, and burden. If section 263A applies to the taxpayer, the basic elements of cost must reflect the current bid price of all direct costs and all indirect costs properly allocable to goods on hand at the inventory date.

Inventory may be valued below cost when the merchandise is unsalable at normal prices or unusable in the normal way because the goods are subnormal due to damage, imperfections, shopwear, etc., within the meaning of Regulations section 1.471-2(c). The goods may be valued at the current bona fide selling price, minus direct cost of disposition (but not less than scrap value) if such a price can be established.

If this is the first year the Last-in, First-out (LIFO) inventory method was either adopted or extended to inventory goods not previously valued under the LIFO method provided in section 472, attach Form 970, Application To Use LIFO Inventory Method, or a statement with the information required by Form 970. Also check the LIFO box on line 9c. On line 9d, enter the amount or the percent of total closing inventories covered under section 472. Estimates are acceptable.

If the corporation changed or extended its inventory method to LIFO and had to write up the opening inventory to cost in the year of election, report the effect of the write-up as other income (line 5, page 1), proportionately over a 3-year period that begins with the year of the LIFO election (section 472(d)).

For more information on inventory valuation methods, see Pub. 538.

Schedule B. Other Information

Complete all items that apply to the corporation.

Item 2

See page 39 and enter the business activity and product or service.

Question 5

Answer “Yes” if the corporation filed, or is required to file, a return under section 6111 to provide information on any reportable transaction by a material advisor. Until Form 8264 is revised or a successor form is issued, this disclosure must be filed using Form 8264 in accordance with Notice 2004-80, 2004-50 I.R.B. 963; Notice 2005-17, 2005-8 I.R.B. 606; and Notice 2005-22, 2005-12 I.R.B. 756.

Item 7

Complete item 7 if the corporation: (a) was a C corporation before it elected to be an S corporation or the corporation acquired an asset with a basis determined by reference to its basis (or the basis of any other property) in the hands of a C corporation and (b) has net unrealized built-in gain (defined below) in excess of the net recognized built-in gain from prior years.

The corporation is liable for section 1374 tax if (a) and (b) above apply and it has a net recognized built-in gain (section 1374(d)(2)) for its tax year.

The corporation's net unrealized built-in gain is the amount, if any, by which the fair market value of the assets of the corporation at the beginning of its first S corporation year (or as of the date the assets were acquired, for any asset with a basis determined by reference to its basis (or the basis of any other property) in the hands of a C corporation) exceeds the aggregate adjusted basis of such assets at that time.

Enter the corporation's net unrealized built-in gain reduced by the net recognized built-in gain for prior years. See sections 1374(c)(2) and (d)(1).

Item 8

If the corporation was a C corporation in a prior year, or if it engaged in a tax-free reorganization with a C corporation, enter the amount of any accumulated earnings and profits (AE&P) at the close of its 2006 tax year. For details on figuring AE&P, see section 312. If the corporation has AE&P, it may be liable for tax imposed on excess net passive income. See the instructions for line 22a, page 1, of Form 1120S for details on this tax.

Question 9

Total receipts is the sum of the following amounts.

Gross receipts or sales (page 1, line 1a).
All other income (page 1, lines 4 and 5).
Income reported on Schedule K, lines 3a, 4, 5a, and 6.
Income or net gain reported on Schedule K, lines 7, 8a, 9, and 10.
Income or net gain reported on Form 8825, lines 2, 19, and 20a.

Schedules K and K-1 (General Instructions)

Purpose of Schedules

The corporation is liable for taxes on lines 22a, 22b, and 22c, on page 1 of Form 1120S. Shareholders are liable for tax on their shares of the corporation's income (reduced by any taxes paid by the corporation on income). Shareholders 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. Schedule K is a summary schedule of all shareholders' shares of the corporation's income, deductions, credits, etc. All corporations must complete Schedule K.

Schedule K-1. Schedule K-1 shows each shareholder's separate share. Attach a copy of each Schedule K-1 to the Form 1120S filed with the IRS. Keep a copy for the corporation's records and give each shareholder a copy.

Give each shareholder a copy of the Shareholder's Instructions for Schedule K-1 (Form 1120S) or specific instructions for each item reported on the shareholder's Schedule K-1.

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. The boxes must use the same numbers and titles and must be in the same order and format as on the comparable IRS Schedule K-1. The substitute schedule must include the OMB number. The corporation must provide each shareholder with the Shareholder's Instructions for Schedule K-1 (Form 1120S) or instructions that apply to the specific items reported on the shareholder's Schedule K-1.

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, SE:W:CAR:MP:T:T:SP, 1111 Constitution Avenue, NW, IR-6406, Washington, DC 20224.

Each shareholder's information must be on a separate sheet of paper. Therefore, separate all continuously printed substitutes before you file them with the IRS.

The corporation may be subject to a penalty if it files a substitute Schedule K-1 that does not conform to the specifications discussed in Pub. 1167, General Rules and Specifications for Substitute Forms and Schedules.

Shareholder's Pro Rata Share Items

General Rule

Items of income, gain, loss, deduction, or credit are allocated to a shareholder on a daily basis, according to the number of shares of stock held by the shareholder on each day of the corporation's tax year. See the detailed instructions for item H in Part II. Information About the Shareholder on page 21.

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 their 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 those 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 (for example, 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, enter “Section 1377(a)(2) Election Made” at the top of each affected shareholder's Schedule K-1.

For more details, see Regulations section 1.1377-1(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 two separate tax years, give the facts relating to the qualifying disposition (for example, 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 qualifying disposition elections for the tax year.

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

Specific Instructions (Schedule K-1 Only)

General Information

Generally, the corporation is required to prepare and give a Schedule K-1 to each person who was a shareholder in the corporation at any time during the tax year. Schedule K-1 must be provided to each shareholder on or before the day on which the corporation's Form 1120S is required to be filed.

General Reporting Information

If the return is for a fiscal year or a short tax year, fill in the tax year space at the top of each Schedule K-1. On each Schedule K-1, enter the information about the corporation and the shareholder in Parts I and II (items A through H). In Part III, enter the shareholder's pro rata share of each item of income, deduction, and credit and any other information the shareholder needs to prepare his or her tax return.

Codes. In box 10 and boxes 12 through 17, identify each item by entering a code in the left column of the entry space. These codes are identified in these instructions and on the back of Schedule K-1.

Attached statements. Enter an asterisk (*) after the code, if any, in the left column of the entry space for each item for which you have attached a statement providing additional information. For items that cannot be reported as a single dollar amount, enter the code and asterisk in the left column and enter “STMT” in the right column to indicate that the information is provided on an attached statement. More than one attached statement can be placed on the same sheet of paper and should be identified in alphanumeric order by box number followed by the letter code (if any). For example: “Box 17, code R— Information needed to figure depletion—oil and gas” (followed by the information the shareholder needs).

Too few entry spaces on Schedule K-1? If the corporation has more coded items than the number of entry spaces in box 10, or boxes 12 through 17, do not enter a code or dollar amount in the last entry space of the box. In the last entry space, enter an asterisk in the left column and enter “STMT” in the entry space to the right. Report the additional items on an attached statement and provide the box number, the code, description, and dollar amount or information for each additional item. For example: “Box 13, code H—Work opportunity credit—$1,000.”

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 Schedule K-1, the corporation must provide information separately for each activity to its shareholders. See Passive Activity Reporting Requirements on page 10 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 activity. See section 465(c) for a definition of activities.

The following information must be provided on an attachment to Schedule K-1 for each activity.

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 any other information that relates to the activity.

Part I. Information About the Corporation

On each Schedule K-1, enter the corporation's name, address, and identifying number.

Item D. Tax Shelter Registration Number

If the corporation is a registration-required tax shelter, it must check this box and enter the tax shelter registration number.

Item E

A corporation that has invested in a registration-required tax shelter must check this box and furnish a copy of its Form 8271, Investor Reporting of Tax Shelter Registration Number, to its shareholders. See Form 8271 for more details.

Part II. Information About the Shareholder

On each Schedule K-1, enter the shareholder's name, address, identifying number, and pro rata share items.

Items F and G

For an individual shareholder, enter the shareholder's social security number (SSN) or individual taxpayer identification number (ITIN) in item F. For all other shareholders, enter the shareholder's EIN.

If a single member limited liability company (LLC) owns stock in the corporation, and the LLC is treated as a disregarded entity for federal income tax purposes, enter the owner's identifying number in item F and the owner's name and address in item G. The owner must be eligible to be an S corporation shareholder. An LLC that elects to be treated as a corporation for federal income tax purposes is not eligible to be an S corporation shareholder.

Item H

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 H for each shareholder. Each shareholder's pro rata share items (boxes 1 through 17 of Schedule K-1) are figured by multiplying the corresponding Schedule K amount by the percentage in item H.

If there was a change in shareholders or in the relative interest in stock the shareholders owned during the tax year, figure the percentage as follows.

Please click here for the text description of the image.

Shareholder chart

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 presented in the illustration and is then entered in item H.
Each shareholder's pro rata share items generally are figured by multiplying the Schedule K amount by the percentage in item H. 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 20 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.

Specific Instructions (Schedules K and K-1, Part III)

Income (Loss)

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

Built-in gains tax (Schedule D, Part III, line 21). 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 (see 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 Business Income (Loss)

Enter the amount from Form 1120S, page 1, line 21. Enter the income (loss) without reference to the shareholder's:

Basis in the stock of the corporation and in any indebtedness of the corporation to the shareholders (section 1366(d)),
At-risk limitations, and
Passive activity limitations.

These limitations, if applicable, are determined at the shareholder level.

Line 1 should not include rental activity income (loss) or portfolio income (loss).

Schedule K-1. Enter each shareholder's pro rata share of ordinary business income (loss) in box 1 of Schedule K-1. If the corporation has more than one trade or business activity, identify on an attachment to Schedule K-1 the amount from each separate activity. See Passive Activity Reporting Requirements on page 10.

Line 2. Net Rental Real Estate Income (Loss)

Enter the net income (loss) from rental real estate activities of the corporation from Form 8825. Attach the form to Form 1120S.

Schedule K-1. Enter each shareholder's pro rata share of net rental real estate income (loss) in box 2 of Schedule K-1. If the corporation has more than one rental real estate activity, identify on an attachment to Schedule K-1 the amount attributable to each activity. See Passive Activity Reporting Requirements on page 10.

Line 3. Other Net Rental Income (Loss)

Enter on line 3a the gross income from rental activities other than those reported on Form 8825. Include on line 3a the gain (loss) from line 17 of Form 4797 that is attributable to the sale, exchange, or involuntary conversion of an asset used in a rental activity other than a rental real estate activity.

Enter on line 3b the deductible expenses of the activity. Attach a statement of these expenses to Form 1120S.

Enter on line 3c the net income (loss).

See Rental Activities on page 7 and Pub. 925, Passive Activity and At-Risk Rules, for more information on rental activities.

Schedule K-1. Enter in box 3 of Schedule K-1 each shareholder's pro rata share of other net rental income (loss) reported on line 3c of Schedule K. If the corporation has more than one rental activity reported in box 3, identify on an attachment to Schedule K-1 the amount from each activity. See Passive Activity Reporting Requirements on page 10.

Portfolio Income

See Portfolio Income on page 8 for a definition of portfolio income.

Do not reduce portfolio income by deductions allocated to it. Report such deductions (other than interest expense) on line 12d of Schedule K. Report each shareholder's pro rata share of deductions in box 12 of Schedule K-1 using codes H, J, and K.

Interest expense allocable to portfolio income is generally investment interest expense reported on line 12b of Schedule K. Report each shareholder's pro rata share of interest expense allocable to portfolio income in box 12 of Schedule K-1 using code G.

Line 4. Interest Income

Enter only taxable portfolio interest on this line. Taxable interest is interest from all sources except interest exempt from tax and interest on tax-free covenant bonds.

Schedule K-1. Enter each shareholder's pro rata share of interest income in box 4 of Schedule K-1.

Line 5a. Ordinary Dividends

Enter only taxable ordinary dividends on line 5a, including any qualified dividends reported on line 5b.

Schedule K-1. Enter each shareholder's pro rata share of ordinary dividends in box 5a of Schedule K-1.

Line 5b. Qualified Dividends

Enter qualified dividends on line 5b. Except as provided below, qualified dividends are dividends received from domestic corporations and qualified foreign corporations.

Exceptions. The following dividends are not qualified dividends.

Dividends the corporation received on any share of stock held for less than 61 days during the 121-day period that began 60 days before the ex-dividend date. When determining the number of days the corporation held the stock, do not count certain days during which the corporation's risk of loss was diminished. The ex-dividend date is the first date following the declaration of a dividend on which the purchaser of a stock is not entitled to receive the next dividend payment. When counting the number of days the corporation held the stock, include the day the corporation disposed of the stock but not the day the corporation acquired it.
Dividends attributable to periods totaling more than 366 days that the corporation received on any share of preferred stock held for less than 91 days during the 181-day period that began 90 days before the ex-dividend date. When determining the number of days the corporation held the stock, do not count certain days during which the corporation's risk of loss was diminished. Preferred dividends attributable to periods totaling less than 367 days are subject to the 61-day holding period rule above.
Dividends that relate to payments that the corporation is obligated to make with respect to short sales or positions in substantially similar or related property.
Dividends paid by a regulated investment company that are not treated as qualified dividend income under section 854.
Dividends paid by a real estate investment trust that are not treated as qualified dividend income under section 857(c).

See Pub. 550 for more details.

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 2006-101, 2006-47 I.R.B. 930, for details.

If the foreign corporation does not meet either 1 or 2, 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 an entity which was a passive foreign investment company (defined in section 1297) in either the tax year of the distribution or the preceding tax year.

See Notice 2004-71, 2004-45 I.R.B. 793, for more details.

Schedule K-1. Enter each shareholder's pro rata share of qualified dividends in box 5b of Schedule K-1.

Line 6. Royalties

Enter the royalties received by the corporation.

Schedule K-1. Enter each shareholder's pro rata share of royalties in box 6 of Schedule K-1.

Line 7. Net Short-Term Capital Gain (Loss)

Enter the gain (loss) from line 6 of Schedule D (Form 1120S).

Schedule K-1. Enter each shareholder's pro rata share of net short-term capital gain (loss) in box 7 of Schedule K-1.

Line 8a. Net Long-Term Capital Gain (Loss)

Enter the gain or loss that is portfolio income (loss) from Schedule D (Form 1120S), line 13.

Schedule K-1. Enter each shareholder's pro rata share of net long-term capital gain (loss) in box 8a of Schedule K-1.

If any gain or loss from lines 6 or 13 of Schedule D is from the disposition of nondepreciable personal property used in a trade or business, it may not be treated as portfolio income. Instead, report it on line 10 of Schedule K and report each shareholder's pro rata share in box 10 of Schedule K-1 using code E.

Line 8b. Collectibles (28%) Gain (Loss)

Figure the amount attributable to collectibles from the amount reported on Schedule D (Form 1120S) line 13. 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, or platinum bullion), gems, stamps, coins, 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).

Schedule K-1. Report each shareholder's pro rata share of the collectibles (28%) gain (loss) in box 8b of Schedule K-1.

Line 8c. Unrecaptured Section 1250 Gain

The three types of unrecaptured section 1250 gain must be reported separately on an attached statement to Form 1120S.

From the sale or exchange of the corporation's business assets. Figure this amount in Part III of Form 4797 for each section 1250 property (except property for which gain is reported using the installment method on Form 6252, Installment Sale Income) for which you had an entry in Part I of Form 4797. Subtract line 26g of Form 4797 from the smaller of line 22 or line 24. 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.

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).

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.

From the sale or exchange of an interest in a partnership. 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 the statement required under Regulations section 1.1(h)-1(e).

From an estate, trust, REIT, or RIC. If the corporation received a Schedule K-1 or Form 1099-DIV from an estate, a trust, a real estate investment trust (REIT), or a regulated investment company (RIC) 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.”

Schedule K-1. Report each shareholder's pro rata share of unrecaptured section 1250 gain from the sale or exchange of the corporation's business assets in box 8c of Schedule K-1. If the corporation is reporting unrecaptured section 1250 gain from an estate, trust, REIT, or RIC or from the corporation's sale or exchange of an interest in a partnership (as explained above), enter “STMT” in box 8c and an asterisk (*) in the left column of the box and attach a statement that separately identifies the amount of unrecaptured section 1250 gain from:

The sale or exchange of the corporation's business assets.
The sale or exchange of an interest in a partnership.
An estate, trust, REIT, or RIC.

Line 9. Net Section 1231 Gain (Loss)

Enter the net section 1231 gain (loss) from Form 4797, line 7, column (g).

Do not include net gain or loss from involuntary conversions due to casualty or theft. Report net loss from involuntary conversions due to casualty or theft on line 10 of Schedule K (box 10, code B, of Schedule K-1). See the instructions for line 10 on how to report net gain from involuntary conversions.

Schedule K-1. Report each shareholder's pro rata share of net section 1231 gain (loss) in box 9 of Schedule K-1. If the corporation has more than one rental, trade, or business activity, identify on an attachment to Schedule K-1 the amount of section 1231 gain (loss) from each separate activity. See Passive Activity Reporting Requirements on page 10.

Line 10. Other Income (Loss)

Enter any other item of income or loss not included on lines 1 through 9. On the dotted line to the left of the entry space for line 10, identify the type of income. If there is more than one type of income, attach a statement to Form 1120S that separately identifies each type and amount of income for each of the following categories. The codes needed for Schedule K-1 reporting are provided for each category.

Other portfolio income (loss) (code A). Portfolio income not reported on lines 4 through 8. Report and identify other portfolio income or loss on an attachment for line 10.

If the corporation holds a residual interest in a REMIC, report on an attachment the shareholder's share of the following.

Taxable income (net loss) from the REMIC (line 1b of Schedules Q (Form 1066)).
Excess inclusion (line 2c of Schedules Q (Form 1066)).
Section 212 expenses (line 3b of Schedules Q (Form 1066)).

Because Schedule Q (Form 1066) is a quarterly statement, the corporation must follow the Schedule Q instructions to figure the amounts to report to shareholders for the corporation's tax year.

Involuntary conversions (code B). Report net loss from involuntary conversions due to casualty or theft. The amount for this item is shown on Form 4684, Casualties and Thefts, line 41a or 41b.

Each shareholder's pro rata share must be entered on Schedule K-1.

Enter the net gain from involuntary conversions of property used in a trade or business (line 42 of Form 4684) on line 3 of Form 4797.

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, notify the shareholder. The corporation should not complete Form 4684 for this type of casualty or theft. Instead, each shareholder will complete his or her own Form 4684.

Section 1256 contracts and straddles (code C). Report any net gain or loss from section 1256 contracts from Form 6781, Gains and Losses From Section 1256 Contracts and Straddles.

Mining exploration costs recapture (code D). Provide the information shareholders need to recapture certain mining exploration expenditures. See Regulations section 1.617-3.

Other income (loss) (code E). Include any other type of income, such as:

Recoveries of tax benefit items (section 111).
Gambling gains and losses subject to the limitations in section 165(d). Indicate on an attached statement whether or not the corporation is in the trade or business of gambling.
Disposition of an interest in oil, gas, geothermal, or other mineral properties. Report the following information on a statement attached to Schedule K-1: (a) a description of the property, (b) the shareholder's share of the amount realized on the sale, exchange, or involuntary conversion of each property (fair market value of the property for any other disposition, such as a distribution), (c) the shareholder's share of the corporation's adjusted basis in the property (except for oil or gas properties), and (d) total intangible drilling costs, development costs, and mining exploration costs (section 59(e) expenditures) passed through to the shareholder for the property. See Regulations section 1.1254-4 for more information.
Gain from the sale or exchange of qualified small business stock (as defined in the Instructions for Schedule D) that is eligible for the partial section 1202 exclusion. The section 1202 exclusion applies only to small business stock held by the corporation for more than 5 years. 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 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. 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 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.
Any gain or loss from lines 5 or 12 of Schedule D that is not portfolio income (for example, gain or loss from the disposition of nondepreciable personal property used in a trade or business).

Schedule K-1. Enter each shareholder's pro rata share of the other income categories listed above in box 10 of Schedule K-1. Enter the applicable code A, B, C, D, or E (as shown above).

If you are reporting each shareholder's pro rata share of only one type of income under code E, enter the code with an asterisk (E*) and the dollar amount in the entry space in box 10 and attach a statement that shows “Box 10, code E,” and the type of income. If you are reporting multiple types of income under code E, enter the code with an asterisk (E*) and enter “STMT” in the entry space in box 10 and attach a statement that shows “Box 10, code E,” and the dollar amount of each type of income.

If the corporation has more than one trade or business or rental activity (for codes B through E), identify on an attachment to Schedule K-1 the amount from each separate activity. See Passive Activity Reporting Requirements on page 10.

Deductions

Line 11. Section 179 Deduction

A corporation can elect to expense part of the cost of certain property the corporation purchased during the tax year for use in its trade or business or certain rental activities. See Pub. 946 for a definition of what kind of property qualifies for the section 179 expense deduction and the Instructions for Form 4562 for limitations on the amount of the section 179 expense deduction.

Complete Part I of Form 4562 to figure the corporation's section 179 expense deduction. The corporation does not take 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 11.

Although the corporation cannot take the section 179 deduction, it generally must still reduce the basis of the asset by the amount of the section 179 deduction it elected, regardless of whether any shareholder can use the deduction. However, the corporation does not reduce the basis for any section 179 deduction allocable to a trust or estate because they are not eligible to take the section 179 deduction. See Regulations section 1.179-1(f).

Identify on an attachment to Schedules K and K-1 the cost of any section 179 property placed in service during the year that is qualified enterprise zone, renewal community, New York Liberty Zone, or section 179 Gulf Opportunity Zone property.

See the instructions for line 17d of Schedule K for sales or other dispositions of property for which a section 179 deduction has passed through to shareholders and for the recapture rules if the business use of the property dropped to 50% or less.

Schedule K-1. Report each shareholder's pro rata share of the section 179 expense deduction in box 11 of Schedule K-1. If the corporation has more than one rental, trade, or business activity, identify on an attachment to Schedule K-1 the amount of section 179 deduction from each separate activity. See Passive Activity Reporting Requirements on page 10.

Do not complete box 11 of Schedule K-1 for any shareholder that is an estate or trust; estates and trusts are not eligible for the section 179 expense deduction.

Line 12a. Contributions

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 return is filed. 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, Noncash Charitable Contributions, described below under Contributions of property.

Cash contributions made in tax years beginning after August 17, 2006, must be supported by a dated bank record or receipt.

Enter the charitable contributions made during the tax year. Attach a statement to Form 1120S that separately identifies the corporation's contributions for each of the following categories. See Limits on Deductions in Pub. 526, Charitable Contributions, for information on adjusted gross income (AGI) limitations on deductions for charitable contributions.

The codes needed for Schedule K-1 reporting are provided for each category.

Cash contributions (50%) (code A). Enter cash contributions subject to the 50% AGI limitation.

Cash contributions (30%) (code B). Enter cash contributions subject to the 30% AGI limitation.

Noncash contributions (50%) (code C). Enter noncash contributions subject to the 50% AGI limitation. Do not include food inventory contributions reported separately on an attached statement. Attach a statement to Schedule K-1 that shows:

The shareholder's pro rata share of the amount of the charitable contributions under section 170(e)(3) for qualified food inventory that was donated to charitable organizations for the care of the ill, needy, and infants. The food must meet all the quality and labeling standards imposed by federal, state, and local laws and regulations. The charitable contribution for donated food inventory is the lesser of (a) the basis of the donated food plus one-half of the appreciation (gain if the donated food were sold at fair market value on the date of the gift) or (b) twice the basis of the donated food.
The shareholder's pro rata share of the net income for the tax year from the corporation's trades or businesses that made the contributions of food inventory.

Qualified conservation contributions. The AGI limit for qualified conservation contributions under section 170(h) is increased from 30% to 50%. The carryover period is increased from 5 years to 15 years. See section 170(b) for details. Report qualified conservation contributions with a 50% AGI limitation on Schedule K-1 in box 12 using code C.

Special rule for contributions of property used in agriculture or livestock production. The AGI limit for qualified conservation contributions of property used in agriculture or livestock production (or available for such production) is increased to 100%. The contribution must be subject to a restriction that the property remain available for such production. See section 170(b) for details. Attach a statement to Schedule K-1 that shows the amount of conservation contributions that qualify for the 100% AGI limitation. Do not include these contributions in the amounts reported in box 12 of Schedule K-1 because shareholders must separately determine if they qualify for the 50% or 100% AGI limitation for these contributions.

Noncash contributions (30%) (code D). Enter noncash contributions subject to the 30% AGI limitation.

Capital gain property to a 50% organization (30%) (code E). Enter capital gain property contributions subject to the 30% AGI limitation.

Capital gain property (20%) (code F). Enter capital gain property contributions subject to the 20% AGI limitation.

Contributions of property. See Contributions of Property in Pub. 526 for information on noncash contributions and contributions of capital gain property. If the deduction claimed for noncash contributions exceeds $500, complete Form 8283 and attach it to Form 1120S.

Shareholders can deduct their pro rata share of the fair market value of property contributions, but will only need to adjust their stock basis by their pro rata share of the property's adjusted basis. Give each shareholder a statement identifying their pro rata share of both the fair market value and adjusted basis of the property.

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.

If the corporation made a contribution after July 25, 2006, of real property located in a registered historic district, new restrictions apply. For contributions made after August 17, 2006, in general, no deduction is allowed for structures or land, only buildings, and the charitable contribution may be reduced if rehabilitation credits were claimed for the building. For contributions made after February 12, 2007, a $500 filing fee may apply to certain deductions over $10,000. See Publication 526 for details.

Nondeductible contributions. Certain contributions made to an organization conducting lobbying activities are not deductible. See section 170(f)(9) for more details. Also, see Contributions You Cannot Deduct in Pub. 526 for more examples of nondeductible contributions.

An accrual basis S corporation cannot 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.

Schedule K-1. Report each shareholder's pro rata share of charitable contributions in box 12 of Schedule K-1 using codes A through F for each of the contribution categories shown on page 25. See Contributions of property on page 25 for information on statements you may be required to attach to Schedule K-1. The corporation must attach a copy of its Form 8283 to the Schedule K-1 of each 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.

Line 12b. 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.

Investment income and investment expenses other than interest are reported on lines 17a and 17b respectively. This information is needed by shareholders to determine the investment interest expense limitation (see Form 4952 for details).

Schedule K-1. Report each shareholder's pro rata share of investment interest expense in box 12 of Schedule K-1 using code G.

Lines 12c(1) and 12c(2). Section 59(e)(2) Expenditures

Generally, section 59(e) allows each shareholder to make an election to deduct their pro rata share of the corporation's otherwise deductible qualified expenditures ratably over 10 years (3 years for circulation expenditures). The deduction is taken 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, these items are not treated as tax preference items.

Because the shareholders make this election, the corporation cannot deduct these amounts or include them as AMT items on Schedule K-1. Instead, the corporation passes through the information the shareholders need to figure their separate deductions.

On line 12c(1), enter the type of expenditures claimed on line 12c(2). Enter on line 12c(2) the qualified expenditures paid or incurred during the tax year for which a shareholder may make an election under section 59(e). Enter this amount for all shareholders whether or not any shareholder makes an election under section 59(e).

On an attached statement, identify the property for which the expenditures were paid or incurred. If the expenditures were for intangible drilling or development costs for oil and gas properties, identify the month(s) in which the expenditures were paid or incurred. If there is more than one type of expenditure or more than one property, provide the amounts (and the months paid or incurred, if required) for each type of expenditure separately for each property.

Schedule K-1. Report each shareholder's pro rata share of section 59(e) expenditures in box 12 of Schedule K-1 using code I. On an attached statement, identify (a) the type of expenditure, (b) the property for which the expenditures are paid or incurred, and (c) for oil and gas properties only, the month in which intangible drilling costs and development costs were paid or incurred. If there is more than one type of expenditure or the expenditures are for more than one property, provide each shareholder's pro rata share of the amounts (and the months paid or incurred for oil and gas properties) for each type of expenditure separately for each property.

Line 12d. Other Deductions

Enter deductions not included on lines 11, 12a, 12b, 12c(2), or 14l. On the dotted line to the left of the entry space for line 12d, identify the type of deduction. If there is more than one type of deduction, attach a statement to Form 1120S that separately identifies the type and amount of each deduction for the following categories. The codes needed for Schedule K-1 reporting are provided for each category.

Deductions—royalty income (code H). Enter deductions related to royalty income.

Deductions—portfolio (2% floor) (code J). Enter deductions related to portfolio income that are subject to the 2% of AGI floor (see the instructions for Schedule A (Form 1040)).

Deductions—portfolio (other) (code K). Enter any other deductions related to portfolio income.

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 12d of Schedule K. The expenses are nondeductible and are reported as such on line 16c of Schedule K and in box 16 of Schedule K-1 using code C.

Preproductive period expenses (code L). If the corporation is required to use an accrual method of accounting under section 448(a)(3), it must capitalize these expenses. If the corporation is permitted to use the cash method, enter the amount of preproductive period expenses that qualify under Regulations section 1.263A-4(d). An election not to capitalize these expenses must be made at the shareholder level. See Uniform Capitalization Rules in Pub. 225.

Commercial revitalization deduction from rental real estate activities (code M). Enter the commercial revitalization deduction on line 12d only if it is for a rental real estate activity. If the deduction is for a nonrental building, enter it on line 19 of Form 1120S. See Special Rules on page 16 for more information.

Reforestation expense deduction (code N). The corporation can elect to deduct a limited amount of its reforestation expenditures paid or incurred during the tax year. Generally, the amount the corporation can elect to deduct is limited to $10,000 for each qualified timber property. However, see the exception for timber property located in the Gulf Opportunity Zones below. See section 194(c) for a definition of reforestation expenditures and qualified timber property. See Notice 2006-47, 2006-20 I.R.B. 892, for details on making the election. The corporation must amortize over 84 months any amount not deducted. See Reforestation expenditures on page 17.

Increased deduction for qualified timber property located in the Gulf Opportunity Zones (GO Zones). For qualified timber property located in the GO Zones for Hurricanes Katrina, Rita, and Wilma, the $10,000 limitation for each property is increased by the lesser of $10,000 or the amount of qualified reforestation expenses paid or incurred by the corporation during the tax year for the qualified timber property.

The increased limitation does not apply to corporations that held more than 500 acres of qualified timber property at any time during the tax year. See section 1400N(i)(1) for details.

Schedule K-1. Enter the shareholder's pro rata share of allowable reforestation expense in box 12 of Schedule K-1 using code N and attach a statement that provides a description of the qualified timber property. If the corporation is electing to deduct amounts from more than one qualified timber property, provide a description and the amount for each property. Indicate if the property is located in the GO Zone for Hurricane Katrina, the GO Zone for Hurricane Rita (other than the Katrina GO Zone), or the GO Zone for Hurricane Wilma.

Domestic production activities information (code O). If the corporation is not using the small business simplified overall method to allocate and apportion cost of goods sold and deductions between domestic production gross receipts and other receipts, attach a statement with the following information to enable each shareholder to figure the domestic production activities deduction.

Domestic production gross receipts (DPGR).
Gross receipts from all sources.
Cost of goods sold allocable to DPGR.
Cost of goods sold from all sources.
Total deductions, expenses, and losses directly allocable to DPGR.
Total deductions, expenses, and losses directly allocable to a non-DPGR class of income.
Other deductions, expenses, and losses not directly allocable to DPGR or another class of income.
Form W-2 wages.
Any other information a shareholder using the section 861 method will need to allocate and apportion cost of goods sold and deductions between domestic production gross receipts and other receipts.

See Form 8903, Domestic Production Activities Deduction, and its instructions for details. If the corporation is using the small business simplified overall method, see the instructions below.

Domestic production activities information (small business simplified overall method). If the corporation elected to use the small business simplified overall method to allocate and apportion cost of goods sold and deductions between domestic production gross receipts and other receipts, report the following information in box 12 of Schedule K-1 using codes P and Q.

Qualified production activities income (code P). Enter the shareholder's pro rata share of the corporation's qualified production activities income computed using the small business simplified overall method. This amount may be less than zero. See the instructions for Form 8903 for details.

Employer's W-2 wages (code Q). Use code Q to report the shareholder's pro rata share of employer's W-2 wages if the corporation has elected to use the small business simplified overall method to apportion cost of goods sold and deductions. If the corporation's tax year began before May 18, 2006, employer's W-2 wages are limited to the lesser of:

The corporation's Form W-2 wages (defined in section 199(b)(2)).
6% of the corporation's qualified production activities income computed using the small business simplified overall method.

If the corporation's tax year began after May 17, 2006, employer's W-2 wages are not subject to the above limit but must be properly allocable to domestic production gross receipts.

Other deductions (code R). Include any other deductions, such as:

Amounts paid by the corporation that would be allowed as itemized deductions on any of the shareholders' income tax returns 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. However, do not enter expenses related to portfolio income or investment interest expense reported on line 12b of Schedule K on this line.
Soil and water conservation expenditures (section 175). See Pub. 225.
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.
Interest expense allocated to debt-financed distributions. See Notice 89-35, 1989-1 C.B. 675, or Pub. 535, chapter 4, for more information.
Contributions to a capital construction fund. See Pub. 595.
Any penalty on early withdrawal of savings because the corporation withdrew funds from its time savings deposit before its maturity.
Film and television production expenses. The corporation can elect to deduct certain costs of a qualified film or television production if the aggregate cost of the production does not exceed $15 million. There is a higher dollar limitation for productions in certain areas. Provide a description of the film or television production on an attached statement. If the corporation makes the election for more than one film or television production, attach a statement to Schedule K-1 that shows each shareholder's pro rata share of the qualified expenditures separately for each production. See section 181 and Notice 2006-47, 2006-20 I.R.B. 892, for details.

Schedule K-1. Enter each shareholder's pro rata share of the deduction categories listed above in box 12 of Schedule K-1 or provide the required information on an attached statement. Enter the applicable code shown above.

If you are reporting only one type of deduction under code R, enter code R with an asterisk (R*) and the dollar amount in the entry space in box 12 and attach a statement that shows the box number, code, and type of deduction. If you are reporting multiple types of deductions under code R, enter the code with an asterisk (R*), enter “STMT” in the dollar amount entry space in box 12, and attach a statement that shows the box number, code, and dollar amount of each type of deduction.

If the corporation has more than one trade or business activity, identify on an attachment to Schedule K-1 the amount for each separate activity. See Passive Activity Reporting Requirements on page 10.

Credits

Do not attach Form 3800, General Business Credit, to Form 1120S.

Low-Income Housing Credit

Section 42 provides a credit that can be claimed by owners of low-income residential rental buildings. To qualify for the credit, the corporation must file Form 8609, Low-Income Housing Credit Allocation and Certification, separately with the IRS. Do not attach Form 8609 to Form 1120S. Complete and attach Form 8586, Low-Income Housing Credit, and Form 8609-A, Annual Statement for Low-Income Housing Credit, to Form 1120S.

Line 13a. Low-Income Housing Credit (Section 42(j)(5))

If the corporation invested in a partnership to which the provisions of section 42(j)(5) apply, report on line 13a the credit reported to the corporation in box 15 of Schedule K-1 (Form 1065) using code A.

Schedule K-1. Report in box 13 of Schedule K-1 each shareholder's pro rata share of the low-income housing credit reported on line 13a of Schedule K using code A. If the corporation has credits from more than one activity, identify on an attachment to Schedule K-1 the amount for each separate activity. See Passive Activity Reporting Requirements on page 10.

Line 13b. Low-Income Housing Credit (Other)

Report on line 13b any low-income housing credit not reported on line 13a. This includes any credit reported to the corporation in box 15 of Schedule K-1 (Form 1065) using code B.

Schedule K-1. Report in box 13 of Schedule K-1 each shareholder's pro rata share of the low-income housing credit reported on line 13b of Schedule K using code B. If the corporation has credits from more than one rental activity, identify on an attachment to Schedule K-1 the amount for each separate activity. See Passive Activity Reporting Requirements on page 10.

Line 13c. Qualified Rehabilitation Expenditures (Rental Real Estate)

Enter on line 13c the total qualified rehabilitation expenditures related to rental real estate activities of the corporation. See Form 3468 for details on qualified rehabilitation expenditures.

Qualified rehabilitation expenditures for property not related to rental real estate activities must be reported in box 17 using code C.

Schedule K-1. Report each shareholder's pro rata share of qualified rehabilitation expenditures related to rental real estate activities in box 13 of Schedule K-1 using code C. Attach a statement to Schedule K-1 that provides the information and the shareholder's pro rata share of the amounts for lines 1b through 1h of Form 3468. See the instructions for Form 3468 for details. If the corporation has expenditures from more than one rental real estate activity, identify on an attachment to Schedule K-1 the information and amounts for each separate activity. See Passive Activity Reporting Requirements on page 10.

Line 13d. Other Rental Real Estate Credits

Enter on line 13d any other credit (other than credits reported on lines 13a through 13c) related to rental real estate activities. On the dotted line to the left of the entry space for line 13d, identify the type of credit. If there is more than one type of credit, attach a statement to Form 1120S that identifies the type and amount for each credit. These credits may include any type of credit listed in the instructions for line 13g.

Schedule K-1. Report in box 13 of Schedule K-1 each shareholder's pro rata share of other rental real estate credits using code D. If you are reporting each shareholder's pro rata share of only one type of rental real estate credit under code D, enter the code with an asterisk (D*) and the dollar amount in the entry space in box 13 and attach a statement that shows “Box 13, code D,” and the type of credit. If you are reporting multiple types of rental real estate credit under code D, enter the code with an asterisk (D*) and enter “STMT” in the entry space in box 13 and attach a statement that shows “Box 13, code D” and the dollar amount of each type of credit. If the corporation has credits from more than one rental real estate activity, identify on the attached statement the amount of each type of credit for each separate activity. See Passive Activity Reporting Requirements on page 10.

Line 13e. Other Rental Credits

Enter on line 13e any other credit (other than credits reported on lines 13a through 13d) related to rental activities. On the dotted line to the left of the entry space for line 13e, identify the type of credit. If there is more than one type of credit, attach a statement to Form 1120S that identifies the type and amount for each credit. These credits may include any type of credit listed in the instructions for line 13g.

Schedule K-1. Report in box 13 of Schedule K-1 each shareholder's pro rata share of other rental credits using code E. If you are reporting each shareholder's pro rata share of only one type of rental credit under code E, enter the code with an asterisk (E*) and the dollar amount in the entry space in box 13 and attach a statement that shows “Box 13, code E” and the type of credit. If you are reporting multiple types of rental credit under code E, enter the code with an asterisk (E*) and enter “STMT” in the entry space in box 13 and attach a statement that shows “Box 13, code E” and the dollar amount of each type of credit. If the corporation has credits from more than one rental activity, identify on the attached statement the amount of each type of credit for each separate activity. See Passive Activity Reporting Requirements on page 10.

Line 13f. Credit for Alcohol Used as Fuel

Enter on line 13f the credit for alcohol used as fuel attributable to trade or business activities. If the credit for alcohol used as fuel is attributable to rental activities, enter the amount on line 13d or 13e.

Figure this credit on Form 6478. Attach it to Form 1120S. Include the amount shown on line 4 of Form 6478 in the corporation's income on line 5 of Form 1120S.

See section 40(f) for an election the corporation can make to have the credit not apply.

Schedule K-1. Report in box 13 of Schedule K-1 each shareholder's pro rata share of the credit for alcohol used as a fuel reported on line 13f using code G.

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 ethanol producer credit included in the total credit allocated to the shareholder, (b) the number of gallons for which the corporation claimed the small ethanol producer credit, and (c) the corporation's productive capacity for alcohol. If the corporation has credits from more than one activity, identify on an attachment to Schedule K-1 the amount for each separate activity. See Passive Activity Reporting Requirements on page 10.

Line 13g. Other Credits

Enter on line 13g any other credit, except credits or expenditures shown or listed for lines 13a through 13f 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 13g, identify the type of credit. If there is more than one type of credit, attach a statement to Form 1120S that separately identifies each type and amount of credit for the following categories. The codes needed for box 13 of Schedule K-1 are provided in the heading of each category.

Undistributed capital gains credit (code F). This credit represents taxes paid on undistributed capital gains by a regulated investment company (RIC) or a real estate investment trust (REIT). As a shareholder of a RIC or REIT, the corporation will receive notice of the amount of tax paid on undistributed capital gains on Form 2439, Notice to Shareholder of Undistributed Long-Term Capital Gains.

Work opportunity credit (code H). Complete Form 5884 to figure the credit. Attach it to Form 1120S.

Welfare-to-work credit (code I). Complete Form 8861 to figure the credit. Attach it to Form 1120S.

Disabled access credit (code J). Complete Form 8826 to figure the credit. Attach it to Form 1120S.

Empowerment zone and renewal community employment credit (code K). Complete Form 8844 to figure the credit. Attach it to Form 1120S.

Credit for increasing research activities (code L). Complete Form 6765 to figure the credit. Attach it to Form 1120S.

New markets credit (code M). Complete Form 8874 to figure the credit. Attach it to Form 1120S.

Credit for employer social security and Medicare taxes paid on certain employee tips (code N). Complete Form 8846 to figure the credit. Attach it to Form 1120S.

Backup withholding (code O). This credit is for backup withholding on dividends, interest, and other types of income of the corporation.

Other credits (code P). Attach a statement to Form 1120S that identifies the type and amount of any other credits not reported elsewhere, such as:

Nonconventional source fuel credit. Complete Form 8907 to figure the credit.
Qualified electric vehicle credit. Complete Form 8834 to figure the credit.
Unused investment credit from cooperatives. See Form 3468.
Renewable electricity, refined coal, and Indian coal production credit. Complete Form 8835 to figure the credit. Attach a statement to Form 1120S and Schedule K-1 showing separately the amount of the credit from Section A and from Section B of Form 8835. Attach Form 8835 to Form 1120S.
Indian employment credit. Complete Form 8845 to figure the credit and attach it to Form 1120S.
Orphan drug credit. Complete Form 8820 to figure the credit and attach it to Form 1120S.
Credit for contributions to selected community development corporations. Complete Form 8847 to figure the credit and attach it to Form 1120S.
Credit for small employer pension plan startup costs. Complete Form 8881 to figure the credit and attach it to Form 1120S.
Credit for employer-provided childcare facilities and services. Complete Form 8882 to figure the credit and attach it to Form 1120S.
Qualified railroad track maintenance credit. Complete Form 8900 to figure the credit and attach it to Form 1120S.
Biodiesel and renewable diesel fuels credit. Complete Form 8864 to figure the credit and attach it to Form 1120S. Include the amount from line 8 of Form 8864 in the corporation's income on line 5 of Form 1120S. If this credit includes the small agri-biodiesel producer credit, identify on a statement attached to Schedule K-1 (a) the small agri-biodiesel producer credit included in the total credit allocated to the shareholder, (b) the number of gallons for which the corporation claimed the small agri-biodiesel producer credit, and (c) the corporation's productive capacity for agri-biodiesel.
Low sulfur diesel fuel production credit. Complete Form 8896 to figure the credit and attach it to Form 1120S.
General credits from an electing large partnership.
Qualified zone academy bond credit. See Form 8860. Include the proper amount in income as explained in the instructions for Form 8860. Also see the instructions for line 17d, code T.
Distilled spirits credit. See Form 8906.
Energy efficient home credit. See Form 8908.
Energy efficient appliance credit. See Form 8909.
Alternative motor vehicle credit. See Form 8910.
Alternative fuel vehicle refueling property credit. See Form 8911.
Clean renewable energy bond credit. Complete Form 8912 to figure the credit and attach it to Form 1120S. See the instructions for Form 8912 to determine if the corporation must include the amount of the credit in interest income. Also see the instructions for line 17d, code T.
Gulf bond credit. Complete Form 8912 to figure the credit and attach it to Form 1120S. See the instructions for Form 8912 to determine if the corporation must include the amount of the credit in interest income. Also see the instructions for line 17d, code T.
Hurricane Katrina housing credit. Complete Section B of Form 5884-A to figure the credit and attach Form 5884-A to Form 1120S.
Mine rescue team training credit. Complete Form 8923 to figure the credit and attach it to Form 1120S.

Schedule K-1. Enter in box 13 of Schedule K-1 each shareholder's pro rata share of the credits listed above. See additional Schedule K-1 reporting information provided in the instructions above. Enter the applicable code, F through P, in the column to the left of the dollar amount entry space.

If you are reporting each shareholder's pro rata share of only one type of credit under code P, enter the code with an asterisk (P*) and the dollar amount in the entry space in box 13 and attach a statement that shows “Box 13, code P” and the type of credit. If you are reporting multiple types of credit under code P, enter the code with an asterisk (P*) and enter “STMT” in the entry space in box 13 and attach a statement that shows “Box 13, code P” and the dollar amount of each type of credit. If the corporation has credits from more than one activity, identify on an attachment to Schedule K-1 the amount of each type of credit for each separate activity. See Passive Activity Reporting Requirements on page 10.

Foreign Transactions

Lines 14a through 14n must be completed if the corporation has foreign income, deductions, or losses, or has paid or accrued foreign taxes.

On Schedule K-1 for the items coded C, E, J, L, M, and N, enter the code followed by an asterisk and the shareholder's pro rata share of the dollar amount. Attach a statement to Schedule K-1 for these coded items providing the information described below. If the corporation had income from, or paid or accrued taxes to, more than one country or U.S. possession, see the requirement for an attached statement in the instruction for line 14a on page 30. See Pub. 514, Foreign Tax Credit for Individuals, and the Instructions for Form 1116, Foreign Tax Credit, for more information.

Line 14a. Name of Country or U.S. Possession (Code A)

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 statement for each country for lines 14a through 14n (codes A through N and code Q of Schedule K-1). On Schedule K-1, if there is more than one country, enter code A followed by an asterisk (A*), enter “STMT,” and attach a statement to Schedule K-1 for each country for the information and amounts coded A through N and Q.

Line 14b. Gross Income From all Sources (Code B)

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

Line 14c. Gross Income Sourced at Shareholder Level (Code C)

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 statement to Form 1120S showing the following information.

The amount of this gross income (without regard to its source) in each category identified in the instructions for lines 14d, 14e, and 14f, 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 collectibles (28%) gains and losses or unrecaptured section 1250 gains.

Lines 14d-14f. 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 more information on the categories of income.

Line 14d (code D). Passive foreign source income.

Line 14e. Listed categories of income (code E). Attach a statement showing the amount of foreign source income included in each of the following listed categories.

High withholding tax interest.
Financial services income.
Shipping income.
Dividends from a domestic international sales corporation (DISC) or a former DISC.
Certain distributions from a foreign sales corporation (FSC) or a former FSC.
Section 901(j) income.
Income re-sourced by treaty.

Line 14f (code F). General limitation foreign source income (all other foreign source income). Include all foreign income sourced at the corporate level that is not reported on lines 14d and 14e.

Lines 14g-14h. Deductions Allocated and Apportioned at Shareholder Level

Line 14g. Interest expense (code G). Enter 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 14i through 14k.

Line 14h. Other (code H). Enter the total of all other deductions or losses that are required to be allocated at the shareholder level. For example, include on line 14h research and experimental expenditures (see Regulations section 1.861-17(f)).

Lines 14i-14k. Deductions Allocated and Apportioned at Corporate Level to Foreign Source Income

Separately report corporate deductions that are apportioned at the corporate level to (a) passive foreign source income, (b) each of the listed foreign categories of income (14e), and (c) general limitation foreign source income (see the instructions for lines 14d-14f). Attach a statement showing the amount of deductions allocated and apportioned at the corporate level to each of the listed categories from line 14e. See Pub. 514 for more information.

Line 14l. Total Foreign Taxes Paid or Accrued

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

Foreign taxes paid (code L). If the corporation used the cash method of accounting, check the “Paid” box and enter foreign taxes paid during the tax year. Report each shareholder's pro rata share in box 14 of Schedule K-1 using code L.

Foreign taxes accrued (code M). If the corporation used the accrual method of accounting, check the “Accrued” box and enter foreign taxes accrued. Report each shareholder's pro rata share in box 14 of Schedule K-1 using code M.

A corporation reporting foreign taxes using the cash method can make an irrevocable election to report the taxes using the accrual method for the year of the election and all future years. Make this election by reporting all foreign taxes using the accrual method on line 14l and checking the “Accrued” box (see Regulations section 1.905-1).

Attach a statement 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 lines 14d-14f).
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 the following.
1. Taxes withheld at source on interest.
2. Taxes withheld at source on dividends.
3. Taxes withheld at source on rents and royalties.
4. Other foreign taxes paid or accrued.

Line 14m. Reduction in Taxes Available for Credit (Code N)

Enter the total reduction in taxes available for credit. Attach a statement 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).

Line 14n. Other Foreign Tax Information

Foreign trading gross receipts (code O). Report each shareholder's pro rata share of foreign trading gross receipts from line 15 of Form 8873 in box 14 using code O. See Extraterritorial Income Exclusion on page 11.
Extraterritorial income exclusion (code P). If the corporation is not permitted to deduct the extraterritorial income exclusion as a non-separately stated item, attach a statement to Schedule K-1 showing the shareholder's pro rata share of the extraterritorial income exclusion reported on line 54 of Form 8873. Also identify the activity to which the exclusion is related.
Other foreign transactions (code Q). Report any other foreign transaction information the shareholders need to prepare their tax returns.

Alternative Minimum Tax (AMT) Items

Lines 15a through 15f must be completed for all shareholders.

Enter items of income and deductions that are adjustments or tax preference items for the AMT. See Form 6251, Alternative Minimum Tax—Individuals, or Schedule I of Form 1041, U.S. Income Tax Return for Estates and Trusts, for more information.

Do not include as a tax preference item any qualified expenditures to which an election under section 59(e) may apply. Instead, report these expenditures on line 12(c)(2). 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 in box 12, code I, of Schedule K-1 the information needed to figure the deduction.

Schedule K-1. Report each shareholder's pro rata share of amounts reported on lines 15a through 15f in box 15 of Schedule K-1 using codes A through F respectively.

If the corporation is reporting items of income or deduction for oil, gas, and geothermal properties, you may be required to identify these items on a statement attached to Schedule K-1 (see the instructions for lines 15d and 15e). Also see the requirement for an attached statement in the instructions for line 15f.

Line 15a. Post-1986 Depreciation Adjustment

Figure the adjustment for line 15a 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 (see 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.

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 15a. 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 15b. 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 statement 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 collectibles (28%) gain (loss).

For a net section 1231 gain (loss), also identify the amount of adjustment that is unrecaptured section 1250 gain.

Line 15c. Depletion (Other Than Oil and Gas)

Do not include any depletion on oil and gas wells. The shareholders must figure their oil and gas 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 figured 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.

Oil, Gas, and Geothermal Properties—Gross Income and Deductions

Generally, the amounts to be entered on lines 15d and 15e are only the income and deductions for oil, gas, and geothermal properties that are used to figure the corporation's ordinary business income (loss) 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 (items not reported on line 1 of Schedule K-1), give each shareholder a statement that shows, for the box in which the income or deduction is included, the amount of income or deductions included in the total amount for that box. Do not include any of these direct pass-through amounts on line 15d or 15e. The shareholder is told in the Shareholder's Instructions for Schedule K-1 (Form 1120S) to adjust the amounts in box 15, code D or E, for any other income or deductions from oil, gas, or geothermal properties included in boxes 2 through 12, 16 or 17 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 15d and 15e separately for oil and gas properties that are not geothermal deposits and for all properties that are geothermal deposits.

Give each shareholder a statement that shows the separate amounts included in the computation of the amounts on lines 15d and 15e of Schedule K.

Line 15d. Oil, Gas, and Geothermal Properties—Gross Income

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 15e. Oil, Gas, and Geothermal Properties—Deductions

Enter any deductions allowed for the AMT that are allocable to oil, gas, and geothermal properties.

Line 15f. Other AMT Items

Attach a statement to Form 1120S and Schedule K-1 that shows other items not shown on lines 15a through 15e 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 AMT 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.

Schedule K-1. If you are reporting each shareholder's pro rata share of only one type of AMT item under code F, enter the code with an asterisk (F*) and the dollar amount in the entry space in box 15 and attach a statement that shows the type of AMT item. If you are reporting multiple types of AMT items under code F, enter the code with an asterisk (F*) and enter “STMT” in the entry space in box 15 and attach a statement that shows the dollar amount of each type of AMT item.

Items Affecting Shareholder Basis

Line 16a. Tax-Exempt Interest Income

Enter on line 16a tax-exempt interest income, including any exempt-interest dividends received from a mutual fund or other regulated investment company. Individual shareholders must report this information on line 8b of Form 1040. Generally, under section 1367(a)(1)(A), the basis of the shareholder's stock is increased by the amount shown on this line.

Line 16b. Other Tax-Exempt Income

Enter on line 16b all income of the corporation exempt from tax other than tax-exempt interest (for example, life insurance proceeds, but see section 101(j) for new limits and reporting requirements). Generally, under section 1367(a)(1)(A), the basis of the shareholder's stock is increased by the amount shown on this line.

Line 16c. Nondeductible Expenses

Enter on line 16c 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, under section 1367(a)(2)(D), the basis of the shareholder's stock is decreased by the amount shown on this line.

Line 16d. Property Distributions

Enter the total property distributions (including cash) made to each shareholder other than dividends reported on line 17c of Schedule K. Distributions of appreciated property are valued at fair market value. See Distributions on page 36 for the ordering rules.

Line 16e. Repayment of Loans From Shareholders

Enter any repayments made to shareholders during the current tax year.

Schedule K-1. Report each shareholder's pro rata share of amounts reported on lines 16a, 16b, and 16c (concerning items affecting shareholder basis) in box 16 of Schedule K-1 using codes A through C respectively. Report property distributions (line 16d) and repayment of loans from shareholders (line 16e) on the Schedule K-1 of the shareholder(s) that received the distributions or repayments (using codes D and E).

Other Information

Lines 17a and 17b. Investment Income and Expenses

Enter on line 17a the investment income included on lines 4, 5a, 6 and 10, of Schedule K. Do not include other portfolio gains or losses on this line.

Enter on line 17b the investment expense included on line 12d of Schedule K.

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, 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), and any qualified dividend income that the shareholder elects to include in investment income. 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.

Schedule K-1. Report each shareholder's pro rata share of amounts reported on lines 17a and 17b (investment income and expenses) in box 17 of Schedule K-1 using codes A and B respectively.

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 statement identifying these amounts.

Line 17c. Dividend Distributions Paid From Accumulated Earnings and Profits (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.

Line 17d. Other Items and Amounts

Report the following information on a statement attached to Form 1120S. On Schedule K-1, enter the appropriate code in box 17 for each information item followed by an asterisk in the left-hand column of the entry space (for example, C*). In the right-hand column, enter “STMT.” The codes are provided for each information category.

Qualified rehabilitation expenditures (other than rental real estate) (code C). Enter total qualified rehabilitation expenditures from activities other than rental real estate activities. See Form 3468 for details on qualified rehabilitation expenditures.

Report qualified rehabilitation expenditures related to rental real estate activities on line 13c.

Schedule K-1. Report each shareholder's pro rata share of qualified rehabilitation expenditures related to other than rental real estate activities in box 17 of Schedule K-1 using code C. Attach a statement to Schedule K-1 that provides the information and the shareholder's pro rata share of the amounts for lines 1b through 1h of Form 3468. See the instructions for Form 3468 for details. If the corporation has expenditures from more than one activity, identify on a statement attached to Schedule K-1 the information and amounts for each separate activity. See Passive Activity Reporting Requirements on page 10.

Basis of energy property (code D). See Form 3468 for details on basis of energy property. In box 17 of Schedule K-1, enter code D followed by an asterisk and enter “STMT” in the entry space for the dollar amount. Attach a statement to Schedule K-1 showing separately the shareholder's pro rata share of the following items:

Basis of property using geothermal energy placed in service during the tax year.
Basis of property using solar illumination or solar energy placed in service during the tax year.
Basis of qualified fuel cell property installed during the tax year.
Kilowatt capacity of the qualified fuel cell property.
Basis of qualified microturbine property installed during the tax year.
Kilowatt capacity of the qualified microturbine property.

Attach Form 3468 to Form 1120S.

Recapture of low-income housing credit (codes E and F). If recapture of part or all of the low-income housing credit is required because (a) the 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. Complete lines 1 through 7 of Form 8611 to figure the amount of the credit to recapture.

Use code E on Schedule K-1 to report recapture of the low-income housing credit from a section 42(j)(5) partnership. Use code F to report recapture of any other low-income housing credit. See the instructions for lines 13a and 13b on page 28 for more information.

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 Schedule K-1.

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

Recapture of investment credit (code G). Complete and attach Form 4255 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 statement 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.

Recapture of other credits (code H). On an attached statement to Schedule K-1, provide any information shareholders will need to report recapture of credits (other than recapture of low-income housing credit and investment credit reported on Schedule K-1 using codes E, F, and G). Examples of credits subject to recapture and reported using code H include:

The qualified electric vehicle credit. See section 30(d) for details.
The new markets credit. See Form 8874 for details on recapture.
The Indian employment credit. See section 45A(d) for details.
The credit for employer-provided childcare facilities and services. See section 45F(d) for details.

Look-back interest—completed long-term contracts (code I). If the corporation is closely held (defined in section 460(b)(4)(C)(iii)) 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 statement to Form 1120S showing the information required in items (a) and (b) of the instructions for lines 1 and 3 of Part II of Form 8697. 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.

Look-back interest—income forecast method (code J). If the corporation is closely held (defined in section 460(b)(4)(C)(iii)) 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.

Dispositions of property with section 179 deductions (code K). This represents gain or loss on the sale, exchange, or other disposition of property for which a section 179 deduction has been passed through to shareholders. The corporation must provide all the following information with respect to such dispositions (see the instructions for line 4 on page 12).

Description of the property.
Date the property was acquired and placed in service.
Date of the sale or other disposition of the property.
The shareholder's pro rata share of the gross sales price or amount realized.
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).
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 deduction.
The shareholder's pro rata share of the section 179 deduction (if any) passed through for the property and the corporation's tax year(s) in which the amount was passed through.
If the disposition is due to a casualty or theft, a statement indicating so, and any additional information needed by the shareholder.
For an installment sale made during the corporation's tax year, any information the shareholder needs to complete Form 6252. 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.) See the instructions for Form 6252 for details.

Recapture of section 179 deduction (code L). This amount represents recapture of the section 179 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 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.

The shareholder's pro rata share of the original basis and depreciation allowed or allowable (not including the section 179 deduction).
The shareholder's pro rata share of the section 179 deduction (if any) passed through for the property and the corporation's tax year(s) in which the amount was passed through.

Section 453(l)(3) information (code M). Supply 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.

Section 453A(c) information (code N). Supply 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.

Section 1260(b) information (code O). Supply any information needed by a shareholder to figure the interest due under section 1260(b). If the corporation had gain from certain constructive ownership transactions, 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.

Interest allocable to production expenditures (code P). Supply 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.

CCF nonqualified withdrawal (code Q). Report nonqualified withdrawals by the corporation from a capital construction fund. Attach a statement to the shareholder's Schedule K-1 providing details of the withdrawal. See Pub. 595.

Information needed to figure depletion—oil and gas (code R). Report gross income and other information relating to oil and gas well properties to shareholders to allow them to figure the depletion deduction for oil and gas well properties. Allocate to each shareholder a proportionate share of the adjusted basis of each corporate oil or gas well property. 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.

Amortization of reforestation costs (code S). Report the amortizable basis of reforestation expenditures paid or incurred before October 23, 2004, for which the corporation elected amortization and the tax year the amortization began for the current tax year and the 7 preceding tax years. The amortizable basis cannot exceed $10,000 for each of those tax years.

Other information (code T). Report to each shareholder:

Any information or statements the shareholders need to allow them to comply with the disclosure requirements under section 6111 and section 6662(d)(2)(B)(ii) and the list keeping requirements of Regulations section 301.6112-1. See Form 8264 and Notice 2004-80, 2004-50 I.R.B. 963; Notice 2005-17, 2005-8 I.R.B. 606; and Notice 2005-22, 2005-12 I.R.B. 756.
If the corporation participates in a transaction that must be disclosed on Form 8886 (see page 6), 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.
If the corporation is involved in farming or fishing activities, report the gross income from these activities.
The shareholder's pro rata share of any amount included in interest income on line 4 with respect to qualified zone academy bonds. Shareholders need this information to properly adjust their stock basis. See Form 8860.
The shareholder's pro rata share of any amount included in interest income on line 4 with respect to clean renewable energy bonds. Shareholders need this information to properly adjust their stock basis. See Form 8912.
The shareholder's pro rata share of any amount included in interest income on line 4 with respect to gulf tax credit bonds. Shareholders need this information to properly adjust their stock basis. See Form 8912.
Any income or gain reported on lines 1 through 10 of Schedule K that qualifies as inversion gain, if the corporation is an expatriated entity or is a partner in an expatriated entity. For details, see section 7874. Attach a statement to Form 1120S that shows the amount of each type of income or gain included in the inversion gain. The corporation must report each shareholder's pro rata share of the inversion gain in box 17 of Schedule K-1 using code T. Attach a statement to Schedule K-1 that shows the shareholder's pro rata share of the amount of each type of income or gain included in the inversion gain.
Basis in qualifying advanced coal project property. Complete lines 3a and 3b of Form 3468 and attach it to Form 1120S. See the instructions for Form 3468 for details. Attach a statement to Schedule K-1 that separately identifies each shareholder's pro rata share of the corporation's (a) basis in certified and qualified investment in integrated gasification combined cycle property placed in service during the tax year and (b) basis of qualified investment in other advanced coal project property placed in service during the tax year.
Basis in qualifying gasification project property. Complete line 4 of Form 3468 and attach it to Form 1120S.
Any other information the shareholders need to prepare their tax returns.

Reconciliation

Line 18. Income/Loss Reconciliation (Schedule K Only)

To the extent the corporation has an amount on line 12d for code O (Domestic production activities information), P (Qualified production activities income), or Q (Employer's W-2 wages), exclude the amount(s) from line 18. If the corporation has an amount on line 14l of Schedule K (foreign taxes paid and accrued), add that amount for purposes of computing the corporation's net income (loss). The amount reported on line 18 must be the same as the amount reported on line 8 of Schedule M-1 or line 26, column d, in Part II of Schedule M-3 (Form 1120S).

Schedule L. Balance Sheets per Books

The balance sheet should agree with the corporation's books and records. Schedule L is not required to be completed if the corporation answered “Yes” to question 9 on Schedule B. If the corporation is required to complete Schedule L, include total assets reported on Schedule L, line 15, column (d), on page 1, item E.

Corporations with total assets of $10 million or more on the last day of the tax year must complete Schedule M-3 (Form 1120S) instead of Schedule M-1. See the separate instructions for Schedule M-3 (Form 1120S) for provisions also affecting Schedule L.

If the S election terminated during the tax year and the corporation reverted to a C corporation, 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 excludable 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

Schedule M-1 is not required to be completed if the corporation answered “Yes” to question 9 on Schedule B.

File Schedule M-3, not Schedule M-1, if the corporation has $10 million or more in assets on last day of tax year.

Corporations with total assets of $10 million or more on the last day of the tax year must complete Schedule M-3 instead of Schedule M-1. See Item H. Schedule M-3 on page 12. A corporation filing Form 1120S that is not required to file Schedule M-3 may voluntarily file Schedule M-3. See the Instructions for Schedule M-3 (Form 1120S) for more information.

Line 2

Report on this line income included on Schedule K, lines 1, 2, 3c, 4, 5a, 6, 7, 8a, 9, and 10 not recorded on the books this year. Describe each such item of income. Attach a statement if necessary.

Line 3b. Travel and Entertainment

Include any of the following.

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

If the corporation has an amount on line 14l of Schedule K (foreign taxes paid and accrued), take that amount into account for purposes of figuring expenses and deductions to enter on lines 3 and 6.

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 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 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). If deductible losses and expenses include the fair market value of contributed property (see page 25), further adjust AAA by adding back the fair market value of the contributed property and subtracting instead the property's adjusted basis. If the total decreases under 2 exceed 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).

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

Schedule M-2Worksheet

		(a) Accumulated adjustments account	(b) Other adjustments account	(c) Shareholders' undistributed taxable income previously taxed
1.	Balance at beginning of tax year	-0-	-0-
2	Ordinary income from page 1, line 21	10,000
3	Other additions	20,000	5,000
4	Loss from page 1, line 21	()
5	Other reductions	(36,000)	()
6	Combine line 1 through 5	(6,000)	5,000
7	Distributions other than dividend distributions	-0-	5,000
8	Balance at end of tax year. Subtract line 7 from line 6	(6,000)	-0-

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 2006 tax year. If there is a beginning balance for the 2006 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 on page 37, 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.
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 (OAA).
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 from this account 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. The E&P at year end is first 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 General rule on page 36 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.

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 4 income—$4,000
Schedule K, line 5a income—$16,000
Schedule K, line 12a deduction—$24,000
Schedule K, line 12d deduction—$3,000
Schedule K, line 13g work opportunity credit—$6,000
Schedule K, line 16a tax-exempt interest—$5,000
Schedule K, line 16c nondeductible expenses—$6,000 (reduction in salaries and wages for work opportunity credit), and
Schedule K, line 16d distributions—$65,000.

Based on items 1 through 10 above 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 on page 36.

For the AAA, the worksheet line 3—$20,000 amount is the total of the Schedule K, lines 4 and 5a 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 12a (code A) deduction of $24,000, line 12d (code R) deduction of $3,000, and the line 16c 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 16a, 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.