S-corp K-1 Supplemental Info

[dsi]

I inherited a new s-corp client this week. In reviewing his K-1 from the prior year, there is a notation that reads: "income subject to self-employment.......$-39,329". I've never seen this before. Any hints?

[Bees Knees]

There is no way a shareholder can be subject to self employment tax. There are court cases that confirm this. The K-1 is wrong.

[Jiggers]

K-1 Wrong

The K-1 is obviously wrong. I would bet that the shareholder took some funds from the S-Corporation and the preparer wrote it off as contract labor. Instead of issuing a 1099, just made that comment on the K-1.

I would have the client tell the preparer to correct the return.

[Roland Slugg]

Just ignore it ... sort of

Dear dsi

I concur that S corps do not generate SE income (or losses), and that the notation on the K-1 is improper. However, it may not be necessary to ask your client to get the S corp's preparer (or former preparer) to prepare a corrected return and K-1.

Where does the $-39,329 appear? It must either be in section 17 of the K-1 or on a supplemental attachment. If so, you can probably just ignore it since it isn't what it says it is. However, I would investigate and see what it really was. If you have access to the S corp's books, it shouldn't be difficult to trace it. It's possible that it represents a loss that belongs on line 1 or one of the other lines on Schedules K and K-1.

[dsi]

Dear dsi

I concur that S corps do not generate SE income (or losses), and that the notation on the K-1 is improper. However, it may not be necessary to ask your client to get the S corp's preparer (or former preparer) to prepare a corrected return and K-1.

Where does the $-39,329 appear? It must either be in section 17 of the K-1 or on a supplemental attachment. If so, you can probably just ignore it since it isn't what it says it is. However, I would investigate and see what it really was. If you have access to the S corp's books, it shouldn't be difficult to trace it. It's possible that it represents a loss that belongs on line 1 or one of the other lines on Schedules K and K-1.

It appears in the "Supplemental" section, bottom of K-1 pg2. The CPA who prepared it is basically retired, and he may not know enough about S-corps to know any better. Also, the s-corp passed through a large loss to the S/H, which he can't use because he has no basis.

[dsi]

Upon further review, I discovered on this client's 1040 that the profit on his Sch C was reduced by the amount on the K-1 in computing SE tax. Very creative I would say!

[Bees Knees]

Upon further review, I discovered on this client's 1040 that the profit on his Sch C was reduced by the amount on the K-1 in computing SE tax. Very creative I would say!

And wrong....

[Unregistered]

Definitely wrong.

[OldJack]

And wrong....

Well... don't jump to conclusions without investigating. This might be possible if the S-corp is passing through tax attributes from another business in which it is an owner. After all an S-corp is a pass thru entity. Inasmuch as I am near retirement, I don't think that suddenly makes me stupid "and he may not know enough about S-corps to know any better". That old gent CPA may know a lot more than any of us on this board and a comment like that is uncalled for.

edit: We should all show a little respect for a fellow professional and his opinions.

[OldJack]

Assuming the S-corp may be a partner in a partnership:


RIA 2006 Federal Tax Handbook, paragraph 3720:
“Each item passed through to the partners and separately stated on their returns has the same character as if realized or incurred directly by the partnership. [code §702(b)] [Reg§1.702-1(b)]”

RIA 2006 Federal Tax Handbook, paragraph 3721:
“A partner must, on his own return, treat a partnership item in a manner that’s consistent with the treatment of that item on the partnership’s return. [Code §6222(a)] A partner that treats a partnership item differently must notify IRS of the inconsistency on Form 8082. [Code §6222(b)]

Sec. 702. Income and credits of partner

-STATUTE-
(a) General rule
In determining his income tax, each partner shall take into
account separately his distributive share of the partnership's -
(1) gains and losses from sales or exchanges of capital assets
held for not more than 1 year,
(2) gains and losses from sales or exchanges of capital assets
held for more than 1 year,
(3) gains and losses from sales or exchanges of property
described in section 1231 (relating to certain property used in a
trade or business and involuntary conversions),
(4) charitable contributions (as defined in section 170(c)),
(5) dividends with respect to which section 1(h)(11) or part
VIII of subchapter B applies,
(6) taxes, described in section 901, paid or accrued to foreign
countries and to possessions of the United States,
(7) other items of income, gain, loss, deduction, or credit, to
the extent provided by regulations prescribed by the Secretary,
and
(8) taxable income or loss, exclusive of items requiring
separate computation under other paragraphs of this subsection.
(b) Character of items constituting distributive share
The character of any item of income, gain, loss, deduction, or
credit included in a partner's distributive share under paragraphs
(1) through (7) of subsection (a) shall be determined as if such
item were realized directly from the source from which realized by
the partnership, or incurred in the same manner as incurred by the
partnership.

[Bees Knees]

Assuming the S-corp may be a partner in a partnership:

An S corporation as a partner in a partnership is not subject to SE tax. Only individuals are subject to SE tax [IRC Section 1402(a), first sentence]. If an individual shareholder of the S corporation performed services for the partnership that the S corporation owned, those services would be subject to FICA tax at the S corporation level, as the S corp shareholder would be working in the capacity as an employee of the S corporation rather than a partner of the S corp owned partnership.

It is impossible under any circumstance for an S corp to pass through SE tax to one of its shareholders.

Care to try again?

[OldJack]

I agree that a S-corp does not pay SE tax because it passes through its income as separately stated items by character of income (ordinary trade or business, capital gains, Interest Income, etc). Income attributes from a partnership, such as interest income, passive activities, etc, are passed to the shareholders with the same character. Such SE taxable income would also pass through with the same character. Were this not the case there would be no individual partners in partnerships except for stupid individuals that don't know anything about S-corps. Your concept is only applicable for the S-corp's trade or business income. I gave you clear cites... where are yours? You really should study S-corp taxation and TTB should cover this situation.

[Bees Knees]

I gave you my cite. Section 1402(a), "The term "net self-employment" means the gross income derived by an individual from any trade or business carried on by such individual..."

In your example, the S corp is the partner in the partnership, not the individual shareholder of the S corp. So the trade or business income from a partnership passed through the S corporation would NOT be subject to SE tax at the S corp shareholder level, since those individuals are not partners of the partnership. The S corp is the partner.

And in your citation, no where does it mention SE tax being passed through the S corporation to the shareholders.

Care to try again?

[Bees Knees]

Before you go off any further down this dead end road, you might want to read the instructions for Form 1120S.

An S corporation that is a partner in a partnership reports line 1, K-1 ordinary income from the partnership on line 5 of the Form 1120S as “other income.” Income reported on line 5 of Form 1120S eventually flows to the S corporation Schedule K-1, line 1, ordinary income or loss, which is not subject to SE tax at the shareholder level.

You might also want to check the line 14a instructions to the Schedule K of Form 1065. Line 14a (net earnings from self-employment) says, “Do not complete this line for any partner that is an estate, trust, corporation, exempt organization, or individual retirement arrangement (IRA).”

Do I need to say any more?

[dsi]

I have read some very interesting arguments on this topic. However, I am compelled to agree with Bees Knees - S-corp income is passed via the K-1 to the S/H as ordinary income. I base this on all of my research and the discussions on this board as well as on other boards. Thanks to all.