SCorp Income Classification

[Burke]

Been reading an old discussion about SCorp income and how defined. Thought came to mind and need your opinions. Sole-owner SCorp in which he actively participates, has gross income due to his actual practice of profession. In addition, however, he receives nominal income paid to SCorp from another party who rents space in his office. Since company owner leases the space, it amounts to a sub-lease. Since he has profits which pass through on the K-1, should this income be isolated and stated separately on the K-1 as rental income? He also takes a salary on W-2. Makes sense to me since investment income is stated separately.

[Bees Knees]

TTB page 19-7 says:

Separately Stated Items
On Form 1120S, net business income and deductions are computed,
and ordinary income or loss is passed through to shareholders
according to their pro-rata percentages. The treatment of
some items, however, might be subject to limits or other special
treatment on the shareholder’s return. These items are separately
stated on Schedule K-1.
Examples of separately stated items include:
• Income or loss from rental real estate.
• Income or loss from other rental activity.
• Interest.
• Dividends.
• Royalties.
• Capital gains and losses.
• Section 1231 gains and losses.
• Investment expenses.
• Charitable contributions.
• Section 179 expense.
• Tax preferences and adjustments for AMT computations.
• Nonbusiness bad debts.
Character of income. The character of any item passed through
from an S corporation to a shareholder is treated as if the shareholder
directly realized or incurred the item. For example, a
short-term capital gain passed through from an S corporation to
a shareholder must be treated as a short-term capital gain by the
shareholder. [IRC §1366(b)]

Note that rental activities are considered Separately Stated Items and thus should not be included in ordinary business income reported on line 1 of the K-1.

[Burke]

Duh. Of course, I knew that. Brain in sleep mode.

[JON]

Bees

is right, however I think there are exceptions for "minor" (my term not IRS). I do not think you book gross rents as the income in this case. If you had a passive loss on something else you can not create passive income at gross by subletting, I think. I do not know the the exact numbers, but if you are going to record it as rental income I think you have to prorate some of the rental expense against it. I also think if it is "minor" "not material" I would offset it against the rental expense.

[Burke]

I see where you are coming from. In this case, TP has other net rental income on Sche E, but no losses, so it would just add to that and reduce ord income flow-thru on K-1. All-in-all, no change in bottom line no matter what we do. Would still be the same net figure on Sche E carried to 1040. Since SCorp leases space itself, it only pays rent, no rental expenses.

[JohnH]

I wonder if this might become an issue going forward if S-Corp income becomes subject to SE tax in the future. It might be important to have a history of classifying rental income separately in prior years in order to exclude it from SE income.

[ChEAr$]

Been reading an old discussion about SCorp income and how defined. Thought came to mind and need your opinions. Sole-owner SCorp in which he actively participates, has gross income due to his actual practice of profession. In addition, however, he receives nominal income paid to SCorp from another party who rents space in his office. Since company owner leases the space, it amounts to a sub-lease. Since he has profits which pass through on the K-1, should this income be isolated and stated separately on the K-1 as rental income? He also takes a salary on W-2. Makes sense to me since investment income is stated separately.

You say that company owner leases the space, (and then subleases part of it to another),
seems to me this has nothing to do with the corporation.
However if corporation subleases space from the owner, then corporation should be
paying owner rental payments also. Then both streams of rental income appear on owner's schedule e.

[Burke]

I wonder if this might become an issue going forward if S-Corp income becomes subject to SE tax in the future. It might be important to have a history of classifying rental income separately in prior years in order to exclude it from SE income.

Yes, the passage of such a law will definitely impact the treatment of this income for tax purposes in the future. So I plan to show it separately as rental income, regardless.

[Burke]

You say that company owner leases the space, (and then subleases part of it to another),
seems to me this has nothing to do with the corporation.
However if corporation subleases space from the owner, then corporation should be
paying owner rental payments also. Then both streams of rental income appear on owner's schedule e.

Sorry, mixed metaphors. Main lease is in name of corporation, who rents entire bldg. Corp sub-leases small office to another party. Sub-lessee pays rent to corporation. So income is shown on books as rental income to corp. Owner of bldg is LLC of which sole-owner is one member. So sole owner gets S-Corp net profit flow-thru on K-1, and rental income from the corp to the LLC.

[ChEAr$]

Sorry, mixed metaphors. Main lease is in name of corporation, who rents entire bldg. Corp sub-leases small office to another party. Sub-lessee pays rent to corporation. So income is shown on books as rental income to corp. Owner of bldg is LLC of which sole-owner is one member. So sole owner gets S-Corp net profit flow-thru on K-1, and rental income from the corp to the LLC.

Ah well, that clarifies it.

Any sublease income would therefore be credited to rental expense, acting merely as a
reduction of rental expense.

[Burke]

Ah well, that clarifies it.

Any sublease income would therefore be credited to rental expense, acting merely as a
reduction of rental expense.

Really? I had thought of that and I treat refunds, rebates and credits that way -- i.e, credit to the expense category -- but was not sure that would be legit treatment in this case. Thanks.