1120 K-1

[cathe]

I have an 1120S client with a LARGE number on his line 1 K-1. The majority of it comes from non return expenses ie: loan principle, etc. He has basically run out of depreciation. He has very little real income from the business, but a lot of basis. Seems I should be able to do something with the basis to reduce this income on his 1040 return, but I am either in la-la land, or clueless on the mechanics of how to get that done.

Any help?

Cathe

[Bees Knees]

Line 1 of the K-1 represents profit. If there isn’t cash in the corporate checkbook, that means the profit is tied up in some type of capital investment, or it was distributed to the shareholder during the year in the form of cash distributions.

You can’t use basis in the stock to reduce income. You can only use basis to deduct losses, or reduce gain upon sale of the stock.

[Burke]

Either check the 1120 income tax return or talk with the person who prepared it. They should be able to document the income/profit.

[JG EA]

I have an 1120S client with a LARGE number on his line 1 K-1. The majority of it comes from non return expenses ie: loan principle, etc. He has basically run out of depreciation. He has very little real income from the business, but a lot of basis. Seems I should be able to do something with the basis to reduce this income on his 1040 return, but I am either in la-la land, or clueless on the mechanics of how to get that done.

Any help?

Cathe

What does that mean "non return expense" ?

Now that you know line 1 is profit, be careful with the return. Is there any payroll? If they took distributions and no payroll and you have a large number on line 1 you could be in a bad position by just reporting it as is.

Take the advice of asking for a copy of the return. Years ago an instructor at a tax seminar told an experience where he put that large number on the tax return. There was no shareholder salary. He did have the client sign a statement that it was correct - or something.

The taxpayer was audited and the taxpayer sued that preparer. The preparer showed the statement he had the man sign and the judge said something like 'if you committed a crime would a letter make it go away?' He lost the case.

[Jiggers]

I have an 1120S client with a LARGE number on his line 1 K-1. The majority of it comes from non return expenses ie: loan principle, etc. He has basically run out of depreciation. He has very little real income from the business, but a lot of basis. Seems I should be able to do something with the basis to reduce this income on his 1040 return, but I am either in la-la land, or clueless on the mechanics of how to get that done.

Any help?

Cathe

K-1 Line 1 has "non return expenses" and "loan principle"? Please explain.

"He has very little real income"? Do you mean distributions from the S-Corp?

Agree with others. If he is the owner of the S-Corp, who did the return? And I would also ask for a copy of the return.

[JohnH]

cathe: Your original question obviously generated lots of other questions, any of which could be pointing you toward this return being a land mine.

Do you think this may be a "Kenny Rogers" client?
♪♪ "You gotta know when to hold 'em, know when to fold 'em.
Know when to walk away, know when to run..." ♪♪

[cathe]

non return expenses

What I meant by non return expenses are the principle loan payments the business makes that are not an expense for the tax return income. The loan has been restructured several times, meanwhile the collateral has depreciated out.

Cathe
.

[JohnH]

So you are saying that the return shows "phantom income" because the loan term is longer than the depreciable period for the underlying asset(s). Principal payments on the loan are continuing, but they are not being offset by depreciation.

That's an unfortunate consequence of taking accelerated depreciation or Sec 179. It's nice when the deduction first appears, but then wash day comes along. Nothing to do at that point but bite the bullet and pay the tax, often for many years to come. Hopefully the client didn't take accelerated depreciaiton at a low tax rate and is now paying tax at a much higher marginal rate - I've seen it happen many times with new clients.

[cathe]

Thanks

Thanks John. At least this clears up a cloudy area for me.

Cathe

[JohnH]

I'm glad it helped. It's important to understand that cash and profit are not the same thing, even for cash-basis taxpayers.

Clients always seem to understand when they get deductions that exceed "cash flows" (also a badly-mangled term), but their understanding becomes murky when they have cash going out and no offsetting tax deduction. I think that's why it is very important to carefully brief them on the consequences of large upfront depreciation deductions on major asset putchases. They have to understand things are going to balance out somewhere in the future.

It's not always easy to answer the question about what happened to the tax deduction for the principal payments on the loan with the simple response - "You got it three years ago".

Personally, I don't believe accelerated depreciation deductions even accomplish their stated economic purposes. The only thing they accomplish is to grab a few headlines, plus they prove that some business people are very gullible when it comes to tax-motivated decisions.