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S Corporations are the most popular business entity in the United States, with over 6 million returns filed annually. That volume means tax practitioners are navigating a lot of 1120-S complexities each year. Knowing the right questions to ask before you start can the S Corporation’s tax return much more streamlined.
To help you through another busy season, we pulled 12 questions directly from our Federal Tax Update, to give you a checklist for S Corporation return preparation. Whether you’re onboarding a new S Corporation client or working with one you’ve served for years, these questions help surface the issues that matter most before they become problems on a filed return.
Ownership changes affect how income is allocated and whether the corporation maintains its S election. S Corporations have strict eligibility rules—limited to 100 shareholders of specific types—and even routine transfers like moving shares into a living trust can trigger problems if the proper trust elections aren’t filed. Catching these issues before the return is filed is far easier than pursuing relief after the fact. Shareholders should also provide: name, address, SSN/EIN, phone and email addresses, including any special attributes of shares (voting only, etc.).
Every Schedule K-1 must include accurate shareholder details. Mismatched Social Security numbers trigger IRS notices, and wrong addresses mean K-1s don’t reach shareholders in time for their personal filings. A quick verification at the start of the engagement prevents downstream headaches. Make sure that all shareholders’ names, addresses, SSN/EIN, phone, and email addresses are collected.
Reasonable compensation is one of the IRS’s most consistent S Corporation audit targets. Shareholder-employees who perform services must receive wages that are reasonable for the work performed—not minimized to avoid payroll taxes. The IRS has been winning cases on this issue for over thirty years, and getting it wrong means reclassified distributions, back taxes, penalties, and interest.
Basis determines whether losses are deductible, whether distributions are tax-free, and what happens when stock is sold. The IRS now requires most shareholders to file Form 7203, which tracks basis annually—so this isn’t something you can defer. Distributions exceeding stock basis are taxable as capital gains, and losses exceeding basis are suspended or permanently lost if stock is disposed of.
Debt basis is one of the most misunderstood areas in S Corporation tax. Only direct loans from the shareholder to the corporation create debt basis—guaranteeing a bank loan does not. How that debt is structured and repaid affects whether repayments are tax-free or generate capital gain income, making the details critical to get right up front.
For new clients especially, this question changes everything. Former C corporations may face a built-in gains tax on appreciated assets sold within the recognition period. There may also be accumulated earnings and profits that complicate distribution ordering and can result in taxable dividends to shareholders.
Asset purchases drive some of the biggest deductions on an S Corporation return. The corporation needs to decide whether to claim bonus depreciation, elect Section 179 expensing, or elect out of bonus depreciation entirely—and the right strategy depends on the shareholders’ overall tax picture, not just the corporation’s.
This question is critical for former C corporations. If the S Corporation has accumulated earnings and profits and passive investment income exceeds 25% of gross receipts, the corporation faces an entity-level tax. Exceed that threshold for three consecutive years, and the S election automatically terminates.
Shareholders who own more than 2% of the corporation are treated differently from regular employees when it comes to benefits like health insurance and group-term life. Health insurance premiums must be included in the shareholder’s W-2 and reported correctly for the personal deduction to work. Getting the payroll treatment wrong creates problems on both the corporate and individual returns.
Related-party transactions are a perennial IRS audit target. Loans lacking proper documentation can be reclassified as distributions, and personal expenses paid by the corporation may be treated as constructive distributions. The key is documentation and arm’s-length terms—you need to know about these transactions so they’re properly reported and defensible.
State compliance has become increasingly complex, especially with pass-through entity tax elections now available in many states as a workaround for the SALT cap. Each state has different rules, deadlines, and calculations. States are also getting more aggressive about asserting nexus for businesses with remote employees or digital sales.
This is your safety net question. Clients don’t always mention IRS notices or state letters unless you ask directly. Unresolved correspondence could indicate unreported income, questions about the S election itself, or outstanding liabilities that affect the return you’re preparing.
Asking your S Corporation clients every year is essential for keeping your S Corporation tax returns streamlined and problem free. S Corporation tax law is full of traps—inadvertent election terminations, basis miscalculations, reasonable compensation challenges, and related-party issues the IRS is actively targeting. A structured intake process built around these 12 questions can help you catch problems early and prepare returns that hold up under scrutiny.
These questions and the tax law behind them are covered in depth in our Federal Tax Update, where you’ll find the latest legislative changes, IRS guidance, and court cases shaping S Corporation practice today.
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