S Corp Income: How Is It Divided?
The core of an S Corp is 'pass-through' taxation. All profits and losses are divided into two buckets
and passed to the shareholders. Understanding this separation is the first step to tax savings.
Bucket 1: Ordinary Business Income (Loss)
This is the net profit or loss from the corporation's main business activities. This amount is aggregated and taxed at the shareholder's personal income tax rate.
(Reported on Form 1120-S, Page 1)
Bucket 2: Separately Stated Items
These are items subject to special tax rules, such as interest, dividends, capital gains/losses, and charitable contributions. Each is passed through separately.
(Reported individually on Schedule K-1)
Interactive Income Calculator
Enter hypothetical financial data below and click 'Calculate' to see the income separation process in action.
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Ordinary Business Expenses
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Separately Stated Items (Total)
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Why Report Items Separately?
Because each item must be treated differently based on the shareholder's personal tax situation. This provides opportunities for personalized tax savings.
Capital Gains/Losses
Can be offset against the shareholder's other capital losses/gains. Long-term capital gains benefit from lower tax rates.
Charitable Contributions
The deduction limit depends on the shareholder's Adjusted Gross Income (AGI). Treating it as a personal itemized deduction can be more beneficial than as a corporate expense.
Section 179 Deduction
Shareholders can deduct the Section 179 expense passed through from the corporation, subject to limits based on their other business income. This allows for individual optimization.
The Flow of Tax Information: Corp to Individual
How do the calculated income items flow to the shareholder's personal tax return (Form 1040)?
S Corporation (Form 1120-S)
Aggregates all corporate income and expenses, separating them into 'Ordinary Business Income' and 'Separately Stated Items'.
Pass-Through to Shareholder (Schedule K-1)
The separated income items are allocated to each shareholder based on their ownership percentage and reported on their individual Schedule K-1.
Ordinary Business Income
The amount from K-1 Box 1 flows to Schedule E of the personal tax return.
Separately Stated Items
Capital gains flow to Schedule D, charitable contributions to Schedule A, etc.
Shareholder's Personal Tax Return (Form 1040)
All income and deduction items are combined to determine the final personal income tax. This is the final step of S Corp 'pass-through taxation'.