US Internal Revenue Service: i1120s--1996

8/14/2019 US Internal Revenue Service: i1120s--1996

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Cat. No. 11515K

ContentsChanges To Note 1

Unresolved Tax Problems 1

How To Make a Contribution To Reducethe Public Debt 1

How To Get Forms and Publications 1

General Instructions 2

Purpose of Form 2

Who Must File 2

Termination of Election 2

When To File 2

Period Covered 2

Where To File 2

Who Must Sign 3

Accounting Methods 3

Accounting Periods 3

Rounding Off to Whole Dollars 3

Recordkeeping 3

Depository Method of Tax Payment 3

Estimated Tax 4

Interest and Penalties 4

Other Forms and Statements ThatMay Be Required 4

Attachments 5

Amended Return 5

Passive Activity Limitations 6

Specific Instructions 9

General Information 9

Income 9

Deductions 10

Tax and Payments 13

Schedule ACost of Goods Sold 14

Schedule BOther Information 14

Designation of Tax MattersPerson (TMP) 15

General Instructions for Schedules Kand K-1 15

Purpose of Schedules 15

Substitute Forms 15

Shareholders Pro Rata Share Items 15

Specific Instructions

(Schedule K Only) 15Specific Instructions

(Schedule K-1 Only) 16

General Information 16

Special Reporting Requirements forCorporations With Multiple Activities 16

Special Reporting Requirements forAt-Risk Activities 16

Specific Items 16

Specific Instructions (Schedules K andK-1, Except as Noted) 16

Income (Loss) 16

Deductions 17

Investment Interest 18

Credits 18

Adjustments and Tax Preference Items 19Foreign Taxes 20

Other 20

Supplemental Information 21

Specific Instructions 22

Schedule LBalance Sheets per Books 22

Schedule M-1Reconciliation ofIncome (Loss) per Books With Income(Loss) per Return 22

Schedule M-2Analysis ofAccumulated Adjustments Account,Other Adjustments Account, and

Shareholders Undistributed TaxableIncome Previously Taxed 22

Codes for Principal Business Activity 24

Changes To NoteThe Small Business Job Protection Act of1996 reinstated certain expired credits andalso changed the rules for claiming certaincredits. The affected credits include:

The work opportunity credit (formerly thejobs credit), which covers qualifiedindividuals who begin work after

September 30, 1996, and before October1, 1997. See Form 5884, WorkOpportunity Credit, for more details.

The credit for increasing researchactivities, which is generally effective foramounts paid or incurred after June 30,1996, and before June 1, 1997. See Form6765, Credit for Increasing ResearchActivities, for more details.

The orphan drug credit, which iseffective for amounts paid or incurred afterJune 30, 1996, and before June 1, 1997.See Form 8820, Orphan Drug Credit, formore details.

The credit for employer social securityand Medicare taxes paid on certain

employee tips. For tips received forservices performed after 1996, this credithas been expanded to coverestablishments that provide food andbeverages for consumption off thepremises (if tipping is customary). SeeForm 8846, Credit for Employer SocialSecurity and Medicare Taxes Paid onCertain Employee Tips, for more details.

Unresolved Tax ProblemsThis Problem Resolution Program is fortaxpayers that have been unable to resolvetheir problems with the IRS. If thecorporation has a tax problem it cannotclear up through normal channels, write to

the corporations local IRS District Directoror call the corporations local IRS officeand ask for Problem Resolution assistance.Persons who have access to TTY/TDDequipment may call 1-800-829-4059 to askfor help from Problem Resolution. Thisoffice cannot change the tax law ortechnical decisions. But it can help thecorporation clear up problems that resultedfrom previous contacts.

How To Make a ContributionTo Reduce the Public DebtTo make a contribution to reduce thepublic debt, send a check made payableto "Bureau of the Public Debt" to Bureau

of the Public Debt, Department G,Washington, DC 20239-0601. Or, enclosea check with Form 1120S. Contributions toreduce the public debt are deductible,subject to the rules and limitations forcharitable contributions.

How To Get Forms andPublications

By Personal Computer

If you subscribe to an on-line service, askif IRS information is available and, if so,

Instructions for Form 1120SU.S. Income Tax Return for an S CorporationSection references are to the Internal Revenue Code unless otherwise noted.

Paperwork Reduction Act NoticeWe ask for the information on these forms to carry out the Internal Revenue laws of theUnited States. You are required to give us the information. We need it to ensure that youare complying with these laws and to allow us to figure and collect the right amount oftax.

The time needed to complete and file this form and related schedules will varydepending on individual circumstances. The estimated average times are:

Copying,assembling, andsending the form

to the IRSPreparing the

formLearning about the law

or the formForm Recordkeeping

35 hr., 59 min.1120S 62 hr., 40 min. 4 hr., 1 min.20 hr., 8 min.

9 hr., 7 min. 1 hr., 20 min.9 hr., 20 min.Sch. D (1120S) 4 hr., 8 min.14 hr., 31 min. 1 hr., 4 min.14 hr., 50 min.Sch. K-1 (1120S) 10 hr., 7 min.

If you have comments concerning the accuracy of these time estimates or suggestionsfor making these forms simpler, we would be happy to hear from you. You can write to theTax Forms Committee, Western Area Distribution Center, Rancho Cordova, CA 95743-0001.DO NOT send the tax form to this address. Instead, see Where To File on page 2.

Department of the TreasuryInternal Revenue Service

You are not required to provide the information requested on a form that is subject tothe Paperwork Reduction Act unless the form displays a valid OMB control number.Books or records relating to a form or its instructions must be retained as long as theircontents may become material in the administration of any Internal Revenue law.Generally, tax returns and return information are confidential, as required by section 6103.

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how to access it. You can get informationthrough IRIS, the Internal RevenueInformation Services, on FedWorld, agovernment bulletin board. Tax forms,instructions, publications, and other IRSinformation are available through IRIS.

IRIS is accessible directly using yourmodem by calling 703-321-8020. On theInternet, telnet to iris.irs.ustreas.gov or, forfile transfer protocol services, connect toftp.irs.ustreas.gov. If you are using theWorld Wide Web, connect tohttp://www.irs.ustreas.gov. FedWorlds

help desk offers technical assistance onaccessing IRIS (not tax help) during regularbusiness hours at 703-487-4608. The IRISmenus offer information on available fileformats and software needed to read andprint files. You must print the forms to usethem; they are not designed to be filled outon-screen.

Tax forms, instructions, and publicationsare also available on CD-ROM, includingprior-year forms starting with the 1991 taxyear. For ordering information and softwarerequirements, contact the GovernmentPrinting Offices Superintendent ofDocuments (202-512-1800) or FederalBulletin Board (202-512-1387).

By Phone and in PersonTo order forms and publications, call1-800-TAX-FORM (1-800-829-3676). Youcan also get most forms and publicationsat your local IRS office.

General Instructions

Purpose of FormForm 1120S is used to report the income,deductions, gains, losses, etc., of adomestic corporation that has elected tobe an S corporation by filing Form 2553,Election by a Small Business Corporation,and whose election is in effect for the tax

year.

Who Must FileA corporation must file Form 1120S if (a) itelected to be an S corporation by filingForm 2553, (b) the IRS accepted theelection, and (c) the election remains ineffect. Do not file Form 1120S until thecorporation has been notified by the IRSthat the election has been accepted.

Termination of ElectionOnce the election is made, it stays ineffect until it is terminated. During the 5years after the election is terminated, the

corporation (or a successor corporation)may make another election on Form 2553only with IRS consent. See Regulationssection 1.1362-5 for more details.

An election terminates automatically inany of the following cases:

1. The corporation is no longer a smallbusiness corporation as defined in section1361(b). The termination of an election inthis manner is effective as of the day onwhich the corporation no longer meets thedefinition of a small business corporation.If the election terminates for this reason,attach to Form 1120S for the final year of

the S corporation a statement notifying theIRS of the termination and the date itoccurred.

2. The corporation, for each of threeconsecutive tax years, (a) has subchapterC earnings and profits and (b) derivesmore than 25% of its gross receipts frompassive investment income as defined insection 1362(d)(3)(D). The electionterminates on the first day of the first taxyear beginning after the third consecutivetax year. The corporation must pay a taxfor each year it has excess net passive

income. See the instructions for line 22afor details on how to figure the tax.

3. The election is revoked. An electionmay be revoked only with the consent ofshareholders who, at the time therevocation is made, hold more than 50%of the number of issued and outstandingshares of stock (including non-votingstock). The revocation may specify aneffective revocation date that is on or afterthe day the revocation is filed. If no date isspecified, the revocation is effective at thestart of a tax year if the revocation is madeon or before the 15th day of the 3rd monthof that tax year. If no date is specified andthe revocation is made after the 15th dayof the 3rd month of the tax year, the

revocation is effective at the start of thenext tax year.

To revoke the election, the corporationmust file a statement with the servicecenter where it filed its election to be an Scorporation. In the statement, thecorporation must notify the IRS that it isrevoking its election to be an Scorporation. The statement must be signedby each shareholder who consents to therevocation and contain the informationrequired by Regulations section1.1362-6(a)(3). A revocation may berescinded before the revocation takeseffect. See Regulations section1.1362-6(a)(4) for details.

For rules on allocating income anddeductions between an S short year and aC short year and other special rules thatapply when an election is terminated, seesection 1362(e) and Regulations section1.1362-3.

If an election was terminated under 1 or2 above, and the corporation believes thetermination was inadvertent, thecorporation may request permission fromthe IRS to continue to be treated as an Scorporation. See Regulations section1.1362-4 for the specific requirements thatmust be met to qualify for inadvertenttermination relief.

When To FileIn general, file Form 1120S by the 15th dayof the 3rd month following the date thecorporations tax year ended as shown atthe top of Form 1120S. For calendar yearcorporations, the due date is March 17,1997. If the due date falls on a Saturday,Sunday, or legal holiday, file on the nextbusiness day. A business day is any daythat is not a Saturday, Sunday, or legalholiday.

If the S election was terminated duringthe tax year, file Form 1120S for the S

short year by the due date (includingextensions) of the C short year return.

Extension

Use Form 7004, Application for AutomaticExtension of Time To File CorporationIncome Tax Return, to request anautomatic 6-month extension of time to fileForm 1120S.

Period CoveredFile the 1996 return for calendar year 1996

and fiscal years beginning in 1996 andending in 1997. If the return is for a fiscalyear or a short tax year, fill in the tax yearspace at the top of the form.

Note: The 1996 Form 1120S may also beused if(a)the corporation has a tax year ofless than 12 months that begins and endsin 1997 and (b)the 1997 Form 1120S isnot available by the time the corporation isrequired to file its return. However, thecorporation must show its 1997 tax year onthe 1996 Form 1120S and incorporate anytax law changes that are effective for taxyears beginning after December 31, 1996.

Where To File

File your return at the applicable IRSaddress listed below.

Holtsville, NY00501-0013

Andover, MA05501-0013

Florida, Georgia,South Carolina

Atlanta, GA 39901-0013

Indiana, Kentucky, Michigan,Ohio, West Virginia

Cincinnati, OH45999-0013

New Jersey, New York (New YorkCity and counties of Nassau,Rockland, Suffolk, andWestchester)

New York (all other counties),Connecticut, Maine,Massachusetts, New Hampshire,Rhode Island, Vermont

Kansas, New Mexico,Oklahoma, Texas

Austin, TX 73301-0013

Alaska, Arizona, California(counties of Alpine, Amador,Butte, Calaveras, Colusa, ContraCosta, Del Norte, El Dorado,Glenn, Humboldt, Lake, Lassen,Marin, Mendocino, Modoc, Napa,Nevada, Placer, Plumas,Sacramento, San Joaquin,Shasta, Sierra, Siskiyou, Solano,Sonoma, Sutter, Tehama, Trinity,Yolo, and Yuba), Colorado, Idaho,Montana, Nebraska, Nevada,North Dakota, Oregon,

South Dakota, Utah, Washington,Wyoming

Ogden, UT84201-0013

If the corporationsprincipal business, office,

or agency is located in

Use the followingInternal RevenueService Center

address

California (all othercounties), Hawaii

Fresno, CA 93888-0013

Illinois, Iowa, Minnesota,Missouri, Wisconsin

Kansas City, MO64999-0013

Alabama, Arkansas,Louisiana, Mississippi,North Carolina, Tennessee

Memphis, TN37501-0013

Delaware, District of Columbia,Maryland, Pennsylvania, Virginia

Philadelphia, PA19255-0013


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Who Must SignThe return must be signed and dated bythe president, vice president, treasurer,assistant treasurer, chief accountingofficer, or any other corporate officer (suchas tax officer) authorized to sign. Areceiver, trustee, or assignee must signand date any return he or she is requiredto file on behalf of a corporation.

If a corporate officer filled in Form1120S, the Paid Preparers space underSignature of officer should remain blank.

If someone prepares Form 1120S anddoes not charge the corporation, thatperson should not sign the return. Certainothers who prepare Form 1120S shouldnot sign. For example, a regular, full-timeemployee of the corporation such as aclerk, secretary, etc., should not sign.

Generally, anyone paid to prepare Form1120S must sign the return and fill in theother blanks in the Paid Preparers UseOnly area of the return.

The preparer required to sign the returnMUST complete the required preparerinformation and:

Sign it, by hand, in the space providedfor the preparers signature. (Signaturestamps or labels are not acceptable.)

Give a copy of Form 1120S to thetaxpayer in addition to the copy filed withthe IRS.

Accounting MethodsFigure ordinary income using the methodof accounting regularly used in keeping thecorporations books and records.Generally, permissible methods include thecash method, the accrual method, or anyother method permitted by the InternalRevenue Code. In all cases, the methodadopted must clearly reflect income.

Generally, an S corporation may not usethe cash method of accounting if the

corporation is a tax shelter (as defined insection 448(d)(3)). See section 448 fordetails.

Under the accrual method, an amount isincludible in income when all the eventshave occurred that fix the right to receivethe income and the amount can bedetermined with reasonable accuracy. SeeRegulations section 1.451-1(a) for details.

Generally, an accrual basis taxpayer candeduct accrued expenses in the tax year inwhich all events that determine liabilityhave occurred, the amount of the liabilitycan be figured with reasonable accuracy,and economic performance takes placewith respect to the expense. There are

exceptions for recurring items and itemsinvolving transactions between relatedtaxpayers described in section 267.

Except for certain home constructioncontracts and other real property smallconstruction contracts, long-term contractsmust generally be accounted for using thepercentage of completion methoddescribed in section 460.

Dealers in securities must use themark-to-market accounting methoddescribed in section 475. Under thismethod, any security that is inventory tothe dealer must be included in inventory at

its fair market value. Any security that isnot inventory and that is held at the closeof the tax year is treated as sold at its fairmarket value on the last business day ofthe tax year, and any gain or loss must betaken into account in determining grossincome. The gain or loss taken intoaccount is generally treated as ordinarygain or loss. For details, includingexceptions, see section 475.

Generally, the corporation may changeits method of accounting used to reporttaxable income (for income as a whole or

for any material item) only by gettingconsent on Form 3115, Application forChange in Accounting Method. For moreinformation, get Pub. 538, AccountingPeriods and Methods.

Accounting PeriodsGenerally, an S corporation may notchange its accounting period to a tax yearthat is not a permitted year. A permittedyear is a calendar year or any otheraccounting period for which thecorporation can establish to thesatisfaction of the IRS that there is abusiness purpose for the tax year.

To change an accounting period, see

Regulations section 1.442-1 and Form1128, Application to Adopt, Change, orRetain a Tax Year. Also see Pub. 538.

Election of a tax year other than arequired year.Under the provisions ofsection 444, an S corporation may elect tohave a tax year other than a permittedyear, but only if the deferral period of thetax year is not longer than the shorter of 3months or the deferral period of the taxyear being changed. This election is madeby filing Form 8716, Election To Have aTax Year Other Than a Required Tax Year.

An S corporation may not make orcontinue an election under section 444 if itis a member of a tiered structure, other

than a tiered structure that consistsentirely of partnerships and S corporationsthat have the same tax year. For the Scorporation to have a section 444 electionin effect, it must make the paymentsrequired by section 7519 and file Form8752, Required Payment or Refund UnderSection 7519.

A section 444 election ends if an Scorporation changes its accounting periodto a calendar year or some other permittedyear, it is penalized for willfully failing tocomply with the requirements of section7519, or its S election is terminated (unlessit immediately becomes a personal servicecorporation). If the termination results in ashort tax year, type or legibly print at the

top of the first page of Form 1120S for theshort tax year, SECTION 444 ELECTIONTERMINATED.

Rounding Off to WholeDollarsYou may round off cents to whole dollarson your return and accompanyingschedules. To do so, drop amounts under50 cents and increase amounts from 50 to99 cents to the next higher dollar.

RecordkeepingThe corporations records must be kept aslong as they may be needed for theadministration of any provision of theInternal Revenue Code. If the consolidatedaudit procedures of sections 6241 through6245 apply to the corporation, records thatsupport an item of income, deduction, orcredit on the corporations return usuallymust be kept for 3 years from the date thereturn is due or is filed, whichever is later.If the consolidated audit procedures do notapply, these records usually must be kept

for 3 years from the date eachshareholders return is due or is filed,whichever is later. Keep records that verifythe corporations basis in property for aslong as they are needed to figure the basisof the original or replacement property.

The corporation should also keep copiesof any returns it has filed. They help inpreparing future returns and in makingcomputations when filing an amendedreturn.

Depository Method of TaxPaymentThe corporation must pay the tax due in

full no later than the 15th day of the 3rdmonth after the end of the tax year. Somecorporations (described below) are requiredto electronically deposit all depositorytaxes, including corporation income taxpayments.

If the corporations total deposits ofsocial security, Medicare, and withheldincome taxes were more than $50,000 in1995, it must make electronic deposits forall depository tax liabilities that occur afterJune 30, 1997. If the corporation wasrequired to deposit by electronic fundstransfer in prior years, it must continue todo so in 1997. The Electronic Federal TaxPayment System (EFTPS) must be usedto make electronic deposits. If the

corporation is required to make depositsby electronic funds transfer and fails to doso, it may be subject to a 10% penalty.Corporations that are not required to makeelectronic deposits may voluntarilyparticipate in EFTPS. For information onEFTPS, call 1-800-945-8400 or1-800-555-4477. (These numbers are forEFTPS information only.)

If the corporation does not use EFTPS,deposit corporation income tax payments(and estimated tax payments) with Form8109, Federal Tax Deposit Coupon. Do notsubmit deposits directly to an IRS office;otherwise, the corporation may have topay a penalty. Mail or deliver thecompleted Form 8109 with the payment toa qualified depositary for Federal taxes orto the Federal Reserve bank (FRB)servicing your geographic area. Make yourchecks or money orders payable to thatdepositary or FRB.

To help ensure proper crediting, writethe corporations employer identificationnumber, the tax period to which thedeposit applies, and Form 1120S on yourcheck or money order. Be sure to darkenthe 1120 box on the coupon. Theserecords of deposit will be sent to the IRS.


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For more information on deposits, seethe instructions in the coupon booklet(Form 8109) and Pub. 583, Starting aBusiness and Keeping Records.

Estimated TaxGenerally, the corporation must makeestimated tax payments for the followingtaxes if the total of these taxes is $500 ormore: (a) the tax on certain capital gains,(b) the tax on built-in gains, (c) the excessnet passive income tax, and (d) theinvestment credit recapture tax.

The amount of estimated tax required tobe paid annually is the lesser of (a) thetotal of the above taxes shown on thereturn for the tax year (or if no return isfiled, the total of these taxes for the year);or (b) the sum of (i) the investment creditrecapture tax and the built-in gains tax (orthe tax on certain capital gains) shown onthe return for the tax year (or if no return isfiled, the total of these taxes for the year),and (ii) any excess net passive income taxshown on the corporations return for thepreceding tax year. If the preceding taxyear was less than 12 months, theestimated tax must be determined under(a).

The estimated tax is generally payable infour equal installments. However, thecorporation may be able to lower theamount of one or more installments byusing the annualized income installmentmethod or adjusted seasonal installmentmethod under section 6655(e).

For a calendar year corporation, thepayments are due for 1997 by April 15,June 16, September 15, and December 15.For a fiscal year corporation, they are dueby the 15th day of the 4th, 6th, 9th, and12th months of the fiscal year.

The corporation must make thepayments using the depository methoddescribed above.

Interest and Penalties

Interest

Interest is charged on taxes not paid bythe due date, even if an extension of timeto file is granted. Interest is also chargedfrom the due date (including extensions) tothe date of payment on the failure to filepenalty, the accuracy-related penalty, andthe fraud penalty. The interest charge isfigured at a rate determined under section6621.

Late Filing of Return

A corporation that does not file its tax

return by the due date, includingextensions, may have to pay a penalty of5% a month, or part of a month, up to amaximum of 25%, for each month thereturn is not filed. The penalty is imposedon the net amount due. The minimumpenalty for filing a return more than 60days late is the smaller of the tax due or$100. The penalty will not be imposed ifthe corporation can show that the failure tofile on time was due to reasonable cause.If the failure is due to reasonable cause,attach an explanation to the return.

Late Payment of Tax

A corporation that does not pay the taxwhen due generally may have to pay apenalty of 12 of 1% a month or part of amonth, up to a maximum of 25%, for eachmonth the tax is not paid. The penalty isimposed on the net amount due.

The penalty will not be imposed if thecorporation can show that failure to pay ontime was due to reasonable cause.

Failure To Furnish Information

TimelySection 6037(b) requires an S corporationto furnish to each shareholder a copy ofthe information shown on Schedule K-1(Form 1120S) that is attached to Form1120S. Provide Schedule K-1 to eachshareholder on or before the day on whichthe corporation files Form 1120S.

For each failure to furnish Schedule K-1to a shareholder when due and eachfailure to include on Schedule K-1 all theinformation required to be shown (or theinclusion of incorrect information), a $50penalty may be imposed with regard toeach Schedule K-1 for which a failureoccurs. If the requirement to report correct

information is intentionally disregarded,each $50 penalty is increased to $100 or, ifgreater, 10% of the aggregate amount ofitems required to be reported. See sections6722 and 6724 for more information.

The penalty will not be imposed if thecorporation can show that not furnishinginformation timely was due to reasonablecause and not due to willful neglect.

Trust Fund Recovery Penalty

This penalty may apply if certain excise,income, social security, and Medicaretaxes that must be collected or withheldare not collected or withheld, or thesetaxes are not paid to the IRS. These taxesare generally reported on Forms 720, 941,

943, or 945. The trust fund recoverypenalty may be imposed on all personswho are determined by the IRS to havebeen responsible for collecting,accounting for, and paying over thesetaxes, and who acted willfully in not doingso. The penalty is equal to the unpaid trustfund tax. See the instructions for Form720, Pub. 15 (Circular E), Employers TaxGuide, or Pub. 51 (Circular A), AgriculturalEmployers Tax Guide, for more details,including the definition of responsiblepersons.

Other Forms and StatementsThat May Be Required Forms W-2 and W-3, Wage and TaxStatement; and Transmittal of Wage andTax Statements.

Form 720, Quarterly Federal Excise TaxReturn. Use Form 720 to reportenvironmental excise taxes,communications and air transportationtaxes, fuel taxes, luxury tax on passengervehicles, manufacturers taxes, shippassenger tax, and certain other excisetaxes.

Caution: SeeTrust Fund RecoveryPenaltyabove.

Form 940 or Form 940-EZ, EmployersAnnual Federal Unemployment (FUTA) TaxReturn. The corporation may be liable forFUTA tax and may have to file Form 940 or940-EZ if it paid wages of $1,500 or morein any calendar quarter during the calendaryear (or the preceding calendar year) orone or more employees worked for thecorporation for some part of a day in any20 different weeks during the calendar year(or the preceding calendar year). Acorporate officer who performs substantialservices is considered an employee.Except as provided in section 3306(a),reasonable compensation for theseservices is subject to FUTA tax, no matterwhat the corporation calls the payments.

Form 941, Employers Quarterly FederalTax Return. Employers must file this formquarterly to report income tax withheld onwages and employer and employee socialsecurity and Medicare taxes. A corporateofficer who performs substantial services isconsidered an employee. Except asprovided in sections 3121(a) and 3401(a),reasonable compensation for theseservices is subject to employer andemployee social security and Medicaretaxes and income tax withholding, nomatter what the corporation calls the

payments. Agricultural employers must fileForm 943, Employers Annual Tax Returnfor Agricultural Employees, instead of Form941, to report income tax withheld andemployer and employee social security andMedicare taxes on farmworkers.


Form 945, Annual Return of WithheldFederal Income Tax. Use this form toreport income tax withheld from nonpayrollpayments, including pensions, annuities,IRAs, gambling winnings, and backupwithholding.


Form 966, Corporate Dissolution orLiquidation.

Forms 1042 and 1042-S, AnnualWithholding Tax Return for U.S. SourceIncome of Foreign Persons; and ForeignPersons U.S. Source Income Subject toWithholding. Use these forms to report andtransmit withheld tax on payments madeto nonresident alien individuals, foreignpartnerships, or foreign corporations to theextent such payments constitute grossincome from sources within the UnitedStates (see sections 861 through 865). Formore information, see sections 1441 and1442, and Pub. 515, Withholding of Tax onNonresident Aliens and ForeignCorporations.

Form 1096, Annual Summary andTransmittal of U.S. Information Returns.

Form 1098, Mortgage InterestStatement. Use this form to report thereceipt from any individual of $600 or moreof mortgage interest and points in thecourse of the corporations t rade orbusiness.

Forms 1099-A, B, DIV, INT, MISC, OID,PATR, R, and S. You may have to filethese information returns to reportabandonments; acquisitions throughforeclosure; proceeds from broker and


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barter exchange transactions; certaindividends; interest payments; medical anddental health care payments;miscellaneous income payments; originalissue discount; patronage dividends;distributions from pensions, annuities,retirement or profit-sharing plans, IRAs,insurance contracts, etc.; and proceedsfrom real estate transactions. Also usecertain of these returns to report amountsthat were received as a nominee on behalfof another person.

Use Form 1099-DIV to report actual

dividends paid by the corporation. Onlydistributions from accumulated earningsand profits are classified as dividends. Donot issue Form 1099-DIV for dividendsreceived by the corporation that areallocated to shareholders on line 4b ofSchedule K-1.

For more information, see the separateInstructions for Forms 1099, 1098, 5498,and W-2G.

Note: Every corporation must file Forms1099-MISC if it makes payments of rents,commissions, or other fixed ordeterminable income (see section 6041)totaling $600 or more to any one person inthe course of its trade or business duringthe calendar year.

Form 5471, Information Return of U.S.Persons With Respect to Certain ForeignCorporations. A corporation may have tofile Form 5471 if any of the followingapplies:

1. It controls a foreign corporation.

2. It acquires, disposes of, or owns 5%or more in value of the outstanding stockof a foreign corporation.

3. It owns stock in a corporation that isa controlled foreign corporation for anuninterrupted period of 30 days or moreduring any tax year of the foreigncorporation, and it owned that stock onthe last day of that year.

Form 5713, International BoycottReport. Every corporation that hadoperations in, or related to, a boycottingcountry, company, or national of a countrymust file Form 5713 to report thoseoperations and figure the loss of certaintax benefits.

Form 8264, Application for Registrationof a Tax Shelter. Tax shelter organizersmust file Form 8264 to register tax shelterswith the IRS for the purpose of receiving atax shelter registration number.

Form 8271, Investor Reporting of TaxShelter Registration Number. Corporationsthat have acquired an interest in a taxshelter that is required to be registered use

Form 8271 to report the tax sheltersregistration number. Attach Form 8271 toany return on which a deduction, credit,loss, or other tax benefit attributable to atax shelter is taken or any incomeattributable to a tax shelter is reported.

Form 8275, Disclosure Statement. FileForm 8275 to disclose items or positions,except those contrary to a regulation, thatare not otherwise adequately disclosed ona tax return. The disclosure is made toavoid the parts of the accuracy-relatedpenalty imposed for disregard of rules orsubstantial understatement of tax. Form8275 is also used for disclosures relating

to preparer penalties for understatementsdue to unrealistic positions or disregard ofrules.

Form 8275-R, Regulation DisclosureStatement, is used to disclose any item ona tax return for which a position has beentaken that is contrary to Treasuryregulations.

Form 8281, Information Return forPublicly Offered Original Issue DiscountInstruments. This form is used by issuersof publicly offered debt instruments havingOID to provide the information required by

section 1275(c). Forms 8288 and 8288-A, U.S.Withholding Tax Return for Dispositions byForeign Persons of U.S. Real PropertyInterests; and Statement of Withholding onDispositions by Foreign Persons of U.S.Real Property Interests. Use these forms toreport and transmit withheld tax on thesale of U.S. real property by a foreignperson. See section 1445 and the relatedregulations for additional information.

Form 8300, Report of Cash PaymentsOver $10,000 Received in a Trade orBusiness. File this form to report thereceipt of more than $10,000 in cash orforeign currency in one transaction (or a

series of related transactions). Form 8594, Asset AcquisitionStatement. Both the purchaser and sellerof a group of assets constituting a trade orbusiness must file this form if section 197intangibles attach, or could attach, to suchassets and if the purchasers basis in theassets is determined only by the amountpaid for the assets.

Form 8697, Interest Computation Underthe Look-Back Method for CompletedLong-Term Contracts. Certain Scorporations that are not closely held mayhave to file Form 8697. Form 8697 is usedto figure the interest due or to be refundedunder the look-back method of section460(b)(2) on certain long-term contractsthat are accounted for under either thepercentage of completion-capitalized costmethod or the percentage of completionmethod. Closely held corporations shouldsee the instructions on page 21 for line 23,item 10, of Schedule K-1 for details on theForm 8697 information they must provideto their shareholders.

Statements

Stock ownership in foreigncorporations.If the corporation owned atleast 5% in value of the outstanding stockof a foreign personal holding company,and the corporation was required toinclude in its gross income anyundistributed foreign personal holdingcompany income, attach the statementrequired by section 551(c).

Transfers to a corporation controlled bythe transferor.If a person receives stockof a corporation in exchange for property,and no gain or loss is recognized undersection 351, the transferor and transfereemust each attach to their tax returns theinformation required by Regulations section1.351-3.

AttachmentsAttach Form 4136, Credit for Federal TaxPaid on Fuels, after page 4, Form 1120S.Attach schedules in alphabetical order andother forms in numerical order after Form4136.

To assist us in processing the return,please complete every applicable entryspace on Form 1120S and Schedule K-1.If you attach statements, do not write Seeattached instead of completing the entryspaces on Form 1120S and Schedule K-1.

If you need more space on the forms orschedules, attach separate sheets. Use thesame size and format as on the printedforms. But show the totals on the printedforms. Attach these separate sheets afterall the schedules and forms. Be sure to putthe corporations name and employeridentification number (EIN) on each sheet.

Amended ReturnTo correct an error on a Form 1120Salready filed, file an amended Form 1120Sand check box F(4). If the amended returnresults in a change to income, or a changein the distribution of any income or otherinformation provided any shareholder, an

amended Schedule K-1 (Form 1120S) mustalso be filed with the amended Form1120S and given to that shareholder. Besure to check box D(2) on each ScheduleK-1 to indicate that it is an amendedSchedule K-1.

Note: If an S corporation does not meetthe small S corporation exception underTemporary Regulations section301.6241-1T or if it is a small S corporationthat has made the election described inTemporary Regulations section301.6241-1T(c)(2)(v), and it files anamended return, the amended return willbe a request for administrative adjustmentand the tax matters person must fileForm8082, Notice of Inconsistent Treatment or

Amended Return (AdministrativeAdjustment Request (AAR)). See thetemporary regulations under section 6241for more information.

A change to the corporations Federalreturn may affect its state return. Thisincludes changes made as the result of anIRS examination of Form 1120S. For moreinformation, contact the state tax agencyfor the state in which the corporationsreturn was filed.

Passive Activity LimitationsIn general, section 469 limits the amount oflosses, deductions, and credits thatshareholders may claim from passiveactivities. The passive activity limitationsdo not apply to the corporation. Instead,they apply to each shareholders share ofany income or loss and credit attributableto a passive activity. Because thetreatment of each shareholders share ofcorporate income or loss and creditdepends upon the nature of the activitythat generated it, the corporation mustreport income or loss and creditsseparately for each activity.

The instructions below (pages 6 through9) and the instructions for Schedules Kand K-1 (pages 15 through 22) explain the


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applicable passive activity limitation rulesand specify the type of information thecorporation must provide to itsshareholders for each activity. If thecorporation had more than one activity, itmust report information for each activity onan attachment to Schedules K and K-1.

Generally, passive activities include(a) activities that involve the conduct of atrade or business in which the shareholderdoes not materially participate and (b) anyrental activity (defined below) even if theshareholder materially participates. For

exceptions, see Activities That Are NotPassive Activities below. The level ofeach shareholders participation in anactivity must be determined by theshareholder.

The passive activity rules provide thatlosses and credits from passive activitiescan generally be applied only againstincome and tax from passive activities.Thus, passive losses and credits cannot beapplied against income from salaries,wages, professional fees, or a business inwhich the shareholder materiallyparticipates; against portfolio income(defined on page 7); or against the taxrelated to any of these types of income.

Special rules require that net incomefrom certain activities that would otherwisebe treated as passive income must berecharacterized as nonpassive income forpurposes of the passive activity limitations.

To allow each shareholder to apply thepassive activity limitations at the individuallevel, the corporation must report incomeor loss and credits separately for each ofthe following: trade or business activities,rental real estate activities, rental activitiesother than rental real estate, and portfolioincome.

Activities That Are NotPassive Activities

Passive activities do not include:

1. Trade or business activities in whichthe shareholder materially participated forthe tax year.

2. Any rental real estate activity in whichthe shareholder materially participated andmet both of the following conditions for thetax year:

a. More than half of the personalservices the shareholder performed intrades or businesses were performed inreal property trades or businesses in whichhe or she materially participated, and

b. The shareholder performed more than750 hours of services in real propertytrades or businesses in which he or she

materially participated.For purposes of this rule, each interest in

rental real estate is a separate activityunless the shareholder elects to treat allinterests in rental real estate as oneactivity.

If the shareholder is married filing jointly,either the shareholder or his or her spousemust separately meet both of the aboveconditions, without taking into accountservices performed by the other spouse.

A real property trade or business is anyreal property development, redevelopment,construction, reconstruction, acquisition,

conversion, rental, operation, management,leasing, or brokerage trade or business.Services the shareholder performed as anemployee are not treated as performed ina real property trade or business unless heor she owned more than 5% of the stockin the employer.

3. The rental of a dwelling unit used by ashareholder for personal purposes duringthe year for more than the greater of 14days or 10% of the number of days thatthe residence was rented at fair rentalvalue.

4. An activity of trading personalproperty for the account of owners ofinterests in the activity. See TemporaryRegulations section 1.469-1T(e)(6).

Note: The section 469(c)(3) exception for aworking interest in oil and gas properties isnot applicable to an S corporation becausestate law generally limits the liability ofcorporate shareholders.

Trade or Business Activities

A trade or business activity is an activity(other than a rental activity or an activitytreated as incidental to an activity ofholding property for investment) that

1. Involves the conduct of a trade or

business (within the meaning of section162),

2. Is conducted in anticipation of startinga trade or business, or

3. Involves research or experimentalexpenditures deductible under section 174(or that would be if you chose to deductrather than capitalize them).

If the shareholder does not materiallyparticipate in the activity, a trade orbusiness activity of the corporation is apassive activity for the shareholder.

Each shareholder must determine if heor she materially participated in an activity.As a result, while the corporations overalltrade or business income (loss) is reportedon page 1 of Form 1120S, the specificincome and deductions from eachseparate trade or business activity must bereported on attachments to Form 1120S.Similarly, while each shareholdersallocable share of the corporations overalltrade or business income (loss) is reportedon line 1 of Schedule K-1, eachshareholders allocable share of theincome and deductions from each trade orbusiness activity must be reported onattachments to each Schedule K-1. SeePassive Activity Reporting Requirementson page 8 for more information.

Rental Activities

Generally, except as noted below, if thegross income from an activity consists ofamounts paid principally for the use of realor personal tangible property held by thecorporation, the activity is a rental activity.

There are several exceptions to thisgeneral rule. Under these exceptions, anactivity involving the use of real or personaltangible property is not a rental activity if(a) the average period of customer use(defined below) for such property is 7 daysor less; (b) the average period of customeruse for such property is 30 days or lessand significant personal services (defined

below) are provided by or on behalf of thecorporation; (c) extraordinary personalservices (defined below) are provided by oron behalf of the corporation; (d) rental ofthe property is treated as incidental to anonrental activity of the corporation underTemporary Regulations section1.469-1T(e)(3)(vi) and Regulations section1.469-1(e)(3)(vi); or (e) the corporationcustomarily makes the property availableduring defined business hours fornonexclusive use by various customers.

In addition, if the corporation provides

property for use in a nonrental activity of apartnership in its capacity as an owner ofan interest in such partnership, theprovision of the property is not a rentalactivity. Consequently, the corporationsdistributive share of income from theactivity is not income from a rental activity.A guaranteed payment described insection 707(c) is not income from a rentalactivity under any circumstances. Whetherthe corporation provides property used inan activity of a partnership in thecorporations capacity as an owner of aninterest in the partnership is based on allthe facts and circumstances.

Average period of customer use.Figure the average period of customer use

of property by dividing the total number ofdays in all rental periods by the number ofrentals during the tax year. If the activityinvolves renting more than one class ofproperty, multiply the average period ofcustomer use of each class by the ratio ofthe gross rental income from that class tothe activitys total gross rental income. Theactivitys average period of customer useequals the sum of these class-by-classaverage periods weighted by grossincome. See Regulations section1.469-1(e)(3)(iii).

Significant personal services.Personalservices include only services performedby individuals. In determining whetherpersonal services are significant personal

services, consider all of the relevant factsand circumstances. Relevant facts andcircumstances include how often theservices are provided, the type andamount of labor required to perform theservices, and the value of the services inrelation to the amount charged for the useof the property.

The following services are notconsidered in determining whetherpersonal services are significant:(a) services necessary to permit the lawfuluse of the rental property; (b) servicesperformed in connection withimprovements or repairs to the rentalproperty that extend the useful life of the

property substantially beyond the averagerental period; and (c) services provided inconnection with the use of any improvedreal property that are similar to thosecommonly provided in connection withlong-term rentals of high-grade commercialor residential property (e.g., cleaning andmaintenance of common areas, routinerepairs, trash collection, elevator service,and security at entrances).

Extraordinary personal services.Services provided in connection withmaking rental property available forcustomer use are extraordinary personalservices only if the services are performed


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by individuals and the customers use ofthe rental property is incidental to theirreceipt of the services. For example, apatients use of a hospital room generallyis incidental to the care that the patientreceives from the hospitals medical staff.Similarly, a students use of a dormitoryroom in a boarding school is incidental tothe personal services provided by theschools teaching staff.

Rental property incidental to a nonrentalactivity.An activity is not a rental activityif the rental of the property is incidental to

a nonrental activity, such as the activity ofholding property for investment, a trade orbusiness activity, or the activity of dealingin property.

Rental property is incidental to anactivity of holding property for investment ifthe main purpose for holding the propertyis to realize a gain from the appreciation ofthe property and the gross rental incomefrom such property for the tax year is lessthan 2% of the smaller of the propertysunadjusted basis or its fair market value.

Rental property is incidental to a trade orbusiness activity if (a) the corporationowns an interest in the trade or businessat all times during the year; (b) the rentalproperty was mainly used in the trade orbusiness activity during the tax year orduring at least 2 of the 5 preceding taxyears; and (c) the gross rental income fromthe property is less than 2% of the smallerof the propertys unadjusted basis or itsfair market value.

The sale or exchange of property that isalso rented during the tax year (where thegain or loss is recognized) is treated asincidental to the activity of dealing inproperty if, at the time of the sale orexchange, the property was held primarilyfor sale to customers in the ordinarycourse of the corporations t rade orbusiness.

See Temporary Regulations section

1.469-1T(e)(3) and Regulations section1.469-1(e)(3) for more information on thedefinition of rental activities for purposes ofthe passive activity limitations.

Reporting of rental activities.Inreporting the corporations income orlosses and credits from rental activities,the corporation must separately report(a) rental real estate activities and(b) rental activities other than rental realestate activities.

Shareholders who actively participate ina rental real estate activity may be able todeduct part or all of their rental real estatelosses (and the deduction equivalent ofrental real estate credits) against income

(or tax) from nonpassive activities.Generally, the combined amount of rentalreal estate losses and the deductionequivalent of rental real estate credits fromall sources (including rental real estateactivities not held through the corporation)that may be claimed is limited to $25,000.

Report rental real estate activity income(loss) on Form 8825, Rental Real EstateIncome and Expenses of a Partnership oran S Corporation, and on line 2 ofSchedules K and K-1 rather than on page1 of Form 1120S. Report credits related torental real estate activities on lines 12c and

12d and low-income housing credits online 12b of Schedules K and K-1.

Report income (loss) from rentalactivities other than rental real estate online 3 and credits related to rental activitiesother than rental real estate on line 12e ofSchedules K and K-1.

Portfolio Income

Generally, portfolio income includes allgross income, other than income derived inthe ordinary course of a trade or business,that is att ributable to interest; d ividends;

royalties; income from a real estateinvestment trust, a regulated investmentcompany, a real estate mortgageinvestment conduit, a common trust fund,a controlled foreign corporation, a qualifiedelecting fund, or a cooperative; incomefrom the disposition of property thatproduces income of a type defined asportfolio income; and income from thedisposition of property held for investment.

Solely for purposes of the precedingparagraph, gross income derived in theordinary course of a trade or businessincludes (and portfolio income, therefore,does not include) only the following typesof income: (a) interest income on loansand investments made in the ordinarycourse of a trade or business of lendingmoney; (b) interest on accounts receivablearising from the performance of services orthe sale of property in the ordinary courseof a trade or business of performing suchservices or selling such property, but onlyif credit is customarily offered to customersof the business; (c) income frominvestments made in the ordinary course ofa trade or business of furnishing insuranceor annuity contracts or reinsuring risksunderwritten by insurance companies;(d) income or gain derived in the ordinarycourse of an activity of trading or dealingin any property if such activity constitutesa trade or business (unless the dealer heldthe property for investment at any timebefore such income or gain is recognized);(e) royalties derived by the taxpayer in theordinary course of a trade or business oflicensing intangible property; (f) amountsincluded in the gross income of a patron ofa cooperative by reason of any payment orallocation to the patron based onpatronage occurring with respect to atrade or business of the patron; and(g) other income identified by the IRS asincome derived by the taxpayer in theordinary course of a trade or business.

See Temporary Regulations section1.469-2T(c)(3) for more information onportfolio income.

Report portfolio income on line 4 of

Schedules K and K-1, rather than onpage 1 of Form 1120S.

Report expenses related to portfolioincome on line 9 of Schedules K and K-1.

Grouping Activities

Generally, one or more trade or businessactivities or rental activities may be treatedas a single activity if the activities make upan appropriate economic unit formeasurement of gain or loss under thepassive activity rules. Whether activitiesmake up an appropriate economic unitdepends on all the relevant facts and

circumstances. The factors given thegreatest weight in determining whetheractivities make up an appropriateeconomic unit are

1. Similarities and differences in types oftrades or businesses,

2. The extent of common control,

3. The extent of common ownership,

4. Geographical location, and

5. Reliance between or among theactivities.

Example: The corporation has asignificant ownership interest in a bakeryand a movie theater in Baltimore and in abakery and a movie theater in Philadelphia.Depending on the relevant facts andcircumstances, there may be more thanone reasonable method for grouping thecorporations activities. For instance, thefollowing groupings may or may not bepermissible: a single activity, a movietheater activity and a bakery activity, aBaltimore activity and a Philadelphiaactivity, or four separate activities.

Once the corporation chooses agrouping under these rules, it mustcontinue using that grouping in later taxyears unless a material change in the facts

and circumstances makes it clearlyinappropriate.

The IRS may regroup the corporationsactivities if the corporations grouping failsto reflect one or more appropriateeconomic units and one of the primarypurposes for the grouping is to avoid thepassive activity limitations.

Limitation on grouping certainactivities.The following activities maynot be grouped together

1. A rental activity with a trade orbusiness activity unless the activities beinggrouped together make up an appropriateeconomic unit, and

a. The rental activity is insubstantial

relative to the trade or business activity orvice versa, or

b. Each owner of the trade or businessactivity has the same proportionateownership interest in the rental activity. Ifso, the portion of he rental activityinvolving the rental of property to be usedin the trade or business activity may begrouped with the trade or business activity.

2. An activity involving the rental of realproperty with an activity involving therental of personal property (except forpersonal property provided in connectionwith real property), or vice versa.

3. Any activity with another activity in adifferent type of business and in which the

corporation holds an interest as a limitedpartner or as a limited entrepreneur (asdefined in section 464(e)(2)) if that otheractivity engages in holding, producing, ordistributing motion picture films orvideotapes; farming; leasing section 1245property; or exploring for (or exploiting) oiland gas resources or geothermal deposits.

Activities conducted throughpartnerships.Once a partnershipdetermines its activities under these rules,the corporation as a partner may use theserules to group those activities with eachother, with activities conducted directly by


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the corporation, and with activitiesconducted through other partnerships. Thecorporation may not treat as separateactivities those activities grouped togetherby the partnership.

Recharacterization of PassiveIncome

Under Temporary Regulations section1.469-2T(f) and Regulations section1.469-2(f), net passive income from certainpassive activities must be treated asnonpassive income. Net passive income is

the excess of an activitys passive activitygross income over its passive activitydeductions (current year deductions andprior year unallowed losses).

Income from the following six sources issubject to recharacterization. Note that anynet passive income recharacterized asnonpassive income is treated asinvestment income for purposes of figuringinvestment interest expense limitations if itis from (a) an activity of rentingsubstantially nondepreciable property froman equity-financed lending activity or (b) anactivity related to an interest in apass-through entity that licenses intangibleproperty.

1. Significant participation passiveactivities.A significant participationpassive activity is any trade or businessactivity in which the shareholder bothparticipates for more than 100 hoursduring the tax year and does not materiallyparticipate. Because each shareholdermust determine his or her level ofparticipation, the corporation will not beable to identify significant participationpassive activities.

2. Certain nondepreciable rentalproperty activities.Net passive incomefrom a rental activity is nonpassive incomeif less than 30% of the unadjusted basis ofthe property used or held for use bycustomers in the activity is subject to

depreciation under section 167.3. Passive equity-financed lending

activities.If the corporation has netincome from a passive equity-financedlending activity, the smaller of the netpassive income or equity-financed interestincome from the activity is nonpassiveincome.

Note: The amount of income from theactivities in items1 through3above thatany shareholder will be required torecharacterize as nonpassive income maybe limited under Temporary Regulationssection 1.469-2T(f)(8). Because thecorporation will not have informationregarding all of a shareholders activities, it

must identify all corporate activitiesmeeting the definitions in items2and3asactivities that may be subject torecharacterization.

4. Rental activities incidental to adevelopment activity.Net rental activityincome is nonpassive income for ashareholder if all of the following apply:(a) the corporation recognizes gain fromthe sale, exchange, or other disposition ofthe rental property during the tax year;(b) the use of the item of property in therental activity started less than 12 monthsbefore the date of disposition (the use of

an item of rental property begins on thefirst day on which (i) the corporation ownsan interest in the property, (ii) substantiallyall of the property is either rented or heldout for rent and ready to be rented, and (iii)no significant value-enhancing servicesremain to be performed); and (c) theshareholder materially participated orsignificantly participated for any tax year inan activity that involved the performance ofservices for the purpose of enhancing thevalue of the property (or any other item ofproperty, if the basis of the propertydisposed of is determined in whole or inpart by reference to the basis of that itemof property). Net rental activity income isthe excess of passive activity grossincome from renting or disposing ofproperty over passive activity deductions(current year deductions and prior yearunallowed losses) that are reasonablyallocable to the rented property.

Because the corporation cannotdetermine a shareholders level ofparticipation, the corporation must identifynet income from property described initems (a) and (b) above as income thatmay be subject to recharacterization.

5. Activities involving property rentedto a nonpassive activity.If a taxpayer

rents property to a trade or businessactivity in which the taxpayer materiallyparticipates, the taxpayers net rentalactivity income (defined above) from theproperty is nonpassive income.

6. Acquisition of an interest in apass-through entity that licensesintangible property.Generally, netroyalty income from intangible property isnonpassive income if the taxpayeracquired an interest in the pass-throughentity after it created the intangibleproperty or performed substantial servicesor incurred substantial costs in developingor marketing the intangible property. Netroyalty income is the excess of passiveactivity gross income from licensing ortransferring any right in intangible propertyover passive activity deductions (currentyear deductions and prior year unallowedlosses) that are reasonably allocable to theintangible property.

See Temporary Regulations section1.469-2T(f)(7)(iii) for exceptions to this rule.

Passive Activity ReportingRequirements

To allow shareholders to correctly applythe passive activity loss and creditlimitation rules, any corporation that carrieson more than one activity must:

1. Provide an attachment for each

activity conducted through the corporationthat identifies the type of activityconducted (trade or business, rental realestate, rental activity other than rental realestate, or investment).

2. On the attachment for each activity,provide a schedule, using the same linenumbers as shown on Schedule K-1,detailing the net income (loss), credits, andall items required to be separately statedunder section 1366(a)(1) from each trade orbusiness activity, from each rental realestate activity, from each rental activity

other than a rental real estate activity, andfrom investments.

3. Identify the net income (loss) and theshareholders share of corporation interestexpense from each activity of renting adwelling unit that any shareholder uses forpersonal purposes during the year for morethan the greater of 14 days or 10% of thenumber of days that the residence isrented at fair rental value.

4. Identify the net income (loss) and theshareholders share of interest expensefrom each activity of trading personal

property conducted through thecorporation.

5. For any gain (loss) from thedisposition of an interest in an activity or ofan interest in property used in an activity(including dispositions before 1987 fromwhich gain is being recognized after 1986):

a. Identify the activity in which theproperty was used at the time ofdisposition;

b. If the property was used in more thanone activity during the 12 monthspreceding the disposition, identify theactivities in which the property was usedand the adjusted basis allocated to eachactivity; and

c. For gains only, if the property wassubstantially appreciated at the time of thedisposition and the applicable holdingperiod specified in Regulations section1.469-2(c)(2)(iii)(A) was not satisfied,identify the amount of the nonpassive gainand indicate whether or not the gain isinvestment income under Regulationssection 1.469-2(c)(2)(iii)(F).

6. Specify the amount of gross portfolioincome, the interest expense properlyallocable to portfolio income, andexpenses other than interest expense thatare clearly and directly allocable toportfolio income.

7. Identify the ratable portion of any

section 481 adjustment (whether a netpositive or a net negative adjustment)allocable to each corporate activity.

8. Identify any gross income fromsources specifically excluded from passiveactivity gross income, including:

a. Income from intangible property, if theshareholder is an individual whosepersonal efforts significantly contributed tothe creation of the property;

b. Income from state, local, or foreignincome tax refunds; and

c. Income from a covenant not tocompete, if the shareholder is an individualwho contributed the covenant to thecorporation.

9. Identify any deductions that are notpassive activity deductions.

10. If the corporation makes a full orpartial disposition of its interest in anotherentity, identify the gain (loss) allocable toeach activity conducted through the entity,and the gain allocable to a passive activitythat would have been recharacterized asnonpassive gain had the corporationdisposed of its interest in property used inthe activity (because the property wassubstantially appreciated at the time of thedisposition, and the gain represented more


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than 10% of the shareholders total gainfrom the disposition).

11. Identify the following items that maybe subject to the recharacterization rulesunder Temporary Regulations section1.469-2T(f) and Regulations section1.469-2(f):

a. Net income from an activity of rentingsubstantially nondepreciable property;

b. The smaller of equity-financed interestincome or net passive income from anequity-financed lending activity;

c. Net rental activity income fromproperty developed (by the shareholder orthe corporation), rented, and sold within 12months after the rental of the propertycommenced;

d. Net rental activity income from therental of property by the corporation to atrade or business activity in which theshareholder had an interest (either directlyor indirectly); and

e. Net royalty income from intangibleproperty if the shareholder acquired theshareholders interest in the corporationafter the corporation created the intangibleproperty or performed substantial servicesor incurred substantial costs in developingor marketing the intangible property.

12. Identify separately the credits fromeach activity conducted by or through thecorporation.

Specific Instructions

General Information

Name, Address, and EmployerIdentification Number

Use the label that was mailed to thecorporation. Cross out any errors and printthe correct information on the label.

Name.If the corporation did not receive

a label, print or type the corporations t ruename (as set forth in the corporate charteror other legal document creating it).

Address.Include the suite, room, orother unit number after the street address.If a preaddressed label is used, pleaseinclude the information on the label. If thePost Office does not deliver to the streetaddress and the corporation has a P.O.box, show the box number instead of thestreet address.

If the corporation changes its mailingaddress after filing its return, it can notifythe IRS by filing Form 8822, Change ofAddress.

Employer identification number (EIN).

Show the correct EIN in item C on page 1of Form 1120S.

Item BBusiness Code No.

See Codes for Principal BusinessActivity on page 24 of these instructions.

Item ETotal Assets

Enter the corporations total assets at theend of the tax year, as determined by theaccounting method regularly used inmaintaining the corporations books andrecords. If there were no assets at the endof the tax year, enter the total assets as of

the beginning of the tax year. If the Selection terminated during the tax year, seethe instructions for Schedule L on page 22for special rules that may apply whenfiguring the corporations year end assets.

Item FInitial Return, FinalReturn, Change in Address, andAmended Return

If this is the corporations first return,check box F(1). If the corporation hasceased to exist, check box F(2). Alsocheck box D(1) on each Schedule K-1 toindicate that it is a final Schedule K-1.Indicate a change in address by checkingbox F(3). If this amends a previously filedreturn, check box F(4). If Schedules K-1are also being amended, check box D(2)on each Schedule K-1.

Item GConsolidated AuditProcedures

With certain exceptions, the tax treatmentof S corporation items is determined at thecorporate level in a consolidated auditproceeding, rather than in separateproceedings with individual shareholders.Check the box for item G if any of thefollowing apply.

The S corporation had more than fiveshareholders at any time during the taxyear (for this purpose a husband and wife,and their estates, are treated as oneshareholder).

Any shareholder was other than anatural person or estate.

The small S corporation (five or fewershareholders) has elected as provided inTemporary Regulations section301.6241-1T(c)(2)(v) to be subject to therules for consolidated proceedings.

Note: The S corporation does not makethe section 301.6241-1T(c)(2)(v) electionwhen it checks the box for item G. Thiselection must be made separately.

For more information on theconsolidated audit procedures for Scorporations, see sections 6241 through6245 and Temporary Regulations section301.6241-1T.

IncomeCaution: Report only trade or businessactivity income or loss on lines 1a through6. Do not report rental activity income orportfolio income or loss on these lines.(See the instructions onPassive ActivityLimitationsbeginning on page 5 fordefinitions of rental income and portfolioincome.) Rental activity income and

portfolio income are reported on SchedulesK and K-1 (rental real estate activities arealso reported on Form 8825).

Do not include any tax-exempt incomeon lines 1 through 5. A corporation thatreceives any exempt income other thaninterest, or holds any property or engagesin an activity that produces exemptincome, reports the amount of this incomeon line 18 of Schedules K and K-1.

Report tax-exempt interest income,including exempt-interest dividendsreceived as a shareholder in a mutual fund

or other regulated investment company, online 17 of Schedules K and K-1.

See Deductions on page 10 forinformation on how to report expensesrelated to tax-exempt income.

If the S corporation has had debtdischarged resulting from a title 11bankruptcy proceeding, or while insolvent,see Form 982, Reduction of Tax AttributesDue to Discharge of Indebtedness, andPub. 908, Bankruptcy Tax Guide.

Line 1Gross Receipts or Sales

Enter gross receipts or sales from all tradeor business operations except those youreport on lines 4 and 5. For reportingadvance payments, see Regulationssection 1.451-5. To report income fromlong-term contracts, see section 460.

Installment sales.Generally, theinstallment method cannot be used fordealer dispositions of property. A dealerdisposition is any disposition of personalproperty by a person who regularly sells orotherwise disposes of property of the sametype on the installment plan or anydisposition of real property held for sale tocustomers in the ordinary course of thetaxpayers trade or business. The

disposition of property used or produced inthe farming business is not included as adealer disposition. See section 453(l) fordetails and exceptions.

Enter on line 1a the gross profit oncollections from installment sales for any ofthe following:

Dealer dispositions of property beforeMarch 1, 1986.

Dispositions of property used orproduced in the trade or business offarming.

Certain dispositions of timeshares andresidential lots reported under theinstallment method.

Attach a schedule showing the followinginformation for the current and the 3preceding years: (a) gross sales, (b) costof goods sold, (c) gross profits,(d) percentage of gross profits to grosssales, (e) amount collected, and (f) grossprofit on the amount collected.

Line 2Cost of Goods Sold

See the instructions for Schedule A.

Line 4Net Gain (Loss) FromForm 4797

Caution: Include only ordinary gains orlosses from the sale, exchange, orinvoluntary conversion of assets used in a

trade or business activity. Ordinary gains orlosses from the sale, exchange, orinvoluntary conversions of assets used inrental activities are reported separately onSchedule K as part of the net income (loss)from the rental activity in which theproperty was used.

A corporation that is a partner in apartnership must include on Form 4797,Sales of Business Property, its share ofordinary gains (losses) from sales,exchanges, or involuntary or compulsoryconversions (other than casualties orthefts) of the partnerships trade orbusiness assets.


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Do not include any recapture of thesection 179 expense deduction. See theinstructions on page 21 for Schedule K-1,line 23, item 3, and the Instructions forForm 4797 for more information.

Line 5Other Income (Loss)

Enter on line 5 trade or business income(loss) that is not included on lines 1athrough 4. Examples of such incomeinclude:

1. Interest income derived in the ordinarycourse of the corporations t rade or

business, such as interest charged onreceivable balances;

2. Recoveries of bad debts deducted inearlier years under the specific charge-offmethod;

3. Taxable income from insuranceproceeds;

4. The amount of credit figured on Form6478, Credit for Alcohol Used as Fuel;

5. All section 481 income adjustmentsresulting from changes in accountingmethods (show the computation on anattached schedule); and

6. Ordinary income (loss) from trade orbusiness activities of a partnership (from

Schedule K-1 (Form 1065), line 1).The corporation must include as other

income the recapture amount for section280F if the business use of listed propertydrops to 50% or less. To figure therecapture amount, the corporation mustcomplete Part IV of Form 4797.

The corporation must also include inother income the amount of any deductionpreviously taken under section 179A that issubject to recapture. The S corporationmay have to recapture the benefit of anyallowable deduction for qualified clean-fuelvehicle property (or clean-fuel vehiclerefueling property), if the property laterceases to qualify for the deduction. SeePub. 535 for details on how to figure therecapture.

Do not include items requiring separatecomputations by shareholders that mustbe reported on Schedules K and K-1. Seethe instructions for Schedules K and K-1beginning on page 15.

If other income consists of only oneitem, identify it by showing the accountcaption in parentheses on line 5. Aseparate schedule need not be attached tothe return in this case.

Do not net any expense item (such asinterest) with a similar income item. Reportall trade or business expenses on lines 7through 19.

DeductionsCaution: Reportonlytrade or businessactivity expenses on lines 7 through 19.

Do not report rental activity expenses ordeductions allocable to portfolio income onthese lines. Rental activity expenses areseparately reported on Form 8825 or line 3of Schedules K and K-1. Deductionsallocable to portfolio income are separatelyreported on line 9 of Schedules K and K-1.See Passive Activity Limitationsbeginning on page 5 for more informationon rental activities and portfolio income.

Do not report any nondeductibleamounts (such as expenses connectedwith the production of tax-exempt income)on lines 7 through 19. Instead, reportnondeductible expenses on line 19 ofSchedules K and K-1. If an expense isconnected with both taxable income andnontaxable income, allocate a reasonablepart of the expense to each kind ofincome.

Limitations on Deductions

Section 263A uniform capitalization

rules.The uniform capitalization rules ofsection 263A require corporations tocapitalize or include in inventory certaincosts incurred in connection with theproduction of real and personal tangibleproperty held in inventory or held for salein the ordinary course of business.Tangible personal property produced by acorporation includes a film, soundrecording, video tape, book, or similarproperty. The rules also apply to personalproperty (tangible and intangible) acquiredfor resale. Corporations subject to the rulesare required to capitalize not only directcosts but an allocable portion of mostindirect costs (including taxes) that benefitthe assets produced or acquired for resale.

Interest expense paid or incurred duringthe production period of certain propertymust be capitalized and is governed byspecial rules. For more information, seeRegulations sections 1.263A-8 through1.263A-15. The uniform capitalization rulesalso apply to the production of propertyconstructed or improved by a corporationfor use in its trade or business or in anactivity engaged in for profit.

Section 263A does not apply to personalproperty acquired for resale if thetaxpayers average annual gross receiptsfor the 3 prior tax years are $10 million orless. It does not apply to timber or to mostproperty produced under a long-termcontract. Special rules apply to certain

corporations engaged in farming (seebelow). The rules do not apply to propertyproduced for use by the taxpayer ifsubstantial construction occurred beforeMarch 1, 1986.

In the case of inventory, some of theindirect costs that must be capitalized areadministration expenses; taxes;depreciation; insurance; compensationpaid to officers attributable to services;rework labor; and contributions to pension,stock bonus, and certain profit-sharing,annuity, or deferred compensation plans.

The costs required to be capitalizedunder section 263A are not deductible untilthe property to which the costs relate is

sold, used, or otherwise disposed of by thecorporation.

Research and experimental costs undersection 174; intangible drilling costs for oil,gas, and geothermal property; and miningexploration and development costs areseparately reported to shareholders forpurposes of determinations under section59(e). Regulations section 1.263A-1(e)(3)specifies other indirect costs that may becurrently deducted and those that must becapitalized with respect to production orresale activities.

For more information, see Regulationssections 1.263A-1 through 1.263A-3.

Special rules for certain corporationsengaged in farming.For S corporationsnot required to use the accrual method ofaccounting, the rules of section 263A donot apply to expenses of raising any(a) animal or (b) plant that has apreproductive period of 2 years or less.Shareholders of S corporations notrequired to use the accrual method ofaccounting may elect to currently deductthe preproductive period expenses of

certain plants that have a preproductiveperiod of more than 2 years. Because theelection to deduct these expenses is madeby the shareholder, the farming corporationshould not capitalize such preproductiveexpenses but should separately reportthese expenses on line 21 of Schedule K,and each shareholders share on line 23 ofSchedule K-1. See sections 263A(d) and(e) and Temporary Regulations section1.263A-4T(c) for definitions and otherdetails. Also see Notice 88-24, 1988-1 C.B.491, and section II(C) of Notice 89-67,1989-1 C.B. 723.

Transactions between relatedtaxpayers.Generally, an accrual basis Scorporation may deduct business

expenses and interest owed to a relatedparty (including any shareholder) only inthe tax year of the corporation thatincludes the day on which the payment isincludible in the income of the relatedparty. See section 267 for details.

Section 291 limitations.If the Scorporation was a C corporation for any ofthe 3 immediately preceding years, thecorporation may be required to adjustdeductions allowed to the corporation fordepletion of iron ore and coal, and theamortizable basis of pollution controlfacilities. See section 291 to determine theamount of the adjustment.

Business start-up expenses.Business

start-up expenses must be capitalized. Anelection may be made to amortize themover a period of not less than 60 months.See section 195.

Reducing certain expenses for whichcredits are allowable.For each of thecredits listed below, the corporation mustreduce the otherwise allowable deductionsfor expenses used to figure the credit bythe amount of the current year credit:

1. The work opportunity credit,

2. The credit for increasing researchactivities,

3. The enhanced oil recovery credit,

4. The disabled access credit,

5. The empowerment zone employmentcredit,

6. The Indian employment credit,

7. The credit for employer social securityand Medicare taxes paid on certainemployee tips, and

8. The orphan drug credit.

If the corporation has any of thesecredits, be sure to figure each current yearcredit before figuring the deductions forexpenses on which the credit is based.


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Line 7Compensation of Officers

Enter on line 7 the total compensation ofall officers paid or incurred in the trade orbusiness activities of the corporation,including fringe benefit expenditures madeon behalf of officers owning more than 2%of the corporations stock. Also reportthese fringe benefits as wages in box 1 ofForm W-2. Do not include on line 7amounts paid or incurred for fringe benefitsof officers owning 2% or less of thecorporations stock. These amounts arereported on line 18, page 1, of Form

1120S. See the instructions for that line forinformation on the types of expendituresthat are treated as fringe benefits and forthe stock ownership rules.

Report amounts paid for healthinsurance coverage for a more than 2%shareholder (including that shareholdersspouse and dependents) as an informationitem in box 14 of that shareholders FormW-2. For 1996, a more than 2%shareholder may be allowed to deduct upto 30% of such amounts on Form 1040,line 26.

Do not include on line 7 compensationreported elsewhere on the return, such asamounts included in cost of goods sold,

elective contributions to a section 401(k)cash or deferred arrangement, or amountscontributed under a salary reduction SEPagreement.

Line 8Salaries and Wages

Enter on line 8 the amount of salaries andwages paid or incurred for the tax year,reduced by any applicable employmentcredits from Form 5884, Work OpportunityCredit, Form 8844, Empowerment ZoneEmployment Credit, and Form 8845, IndianEmployment Credit. See the instructionsfor these forms for more information.Include fringe benefit expenditures madeon behalf of employees (other than officers)owning more than 2% of the corporations

stock. Also report these fringe benefits aswages in box 1 of Form W-2. Do notinclude on line 8 amounts paid or incurredfor fringe benefits of employees owning2% or less of the corporations stock.These amounts are reported on line 18,page 1, of Form 1120S. See theinstructions for that line for information onthe types of expenditures that are treatedas fringe benefits and for the stockownership rules.

Report amounts paid for healthinsurance coverage for a more than 2%shareholder (including that shareholdersspouse and dependents) as an informationitem in box 14 of that shareholders FormW-2. For 1996, a more than 2%shareholder may be allowed to deduct upto 30% of such amounts on Form 1040,line 26.

Do not include on line 8 salaries andwages reported elsewhere on the return,such as amounts included in cost of goodssold, elective contributions to a section401(k) cash or deferred arrangement, oramounts contributed under a salaryreduction SEP agreement.

If a shareholder or a member of thefamily of one or more shareholders of thecorporation renders services or furnishes

capital to the corporation for whichreasonable compensation is not paid, theIRS may make adjustments in the itemstaken into account by such individuals andthe value of such services or capital. Seesection 1366(e).

Line 9Repairs and Maintenance

Enter the costs of incidental repairs andmaintenance, such as labor and supplies,that do not add to the value of theproperty or appreciably prolong its life, butonly to the extent that such costs relate to

a trade or business activity and are notclaimed elsewhere on the return. Newbuildings, machinery, or permanentimprovements that increase the value ofthe property are not deductible. They arechargeable to capital accounts and may bedepreciated or amortized.

Line 10Bad Debts

Enter the total debts that becameworthless in whole or in part during theyear, but only to the extent such debtsrelate to a trade or business activity.Report deductible nonbusiness bad debtsas a short-term capital loss on Schedule D(Form 1120S).

Caution: Cash method taxpayers cannottake a bad debt deduction unless theamount was previously included in income.

Line 11Rents

If the corporation rented or leased avehicle, enter the total annual rent or leaseexpense paid or incurred in the trade orbusiness activities of the corporation. Alsocomplete Part V of Form 4562,Depreciation and Amortization. If thecorporation leased a vehicle for a term of30 days or more, the deduction for vehiclelease expense may have to be reduced byan amount called the inclusion amount.The corporation may have an inclusionamount if

The lease term began:

And the vehiclesfair market value onthe first day of thelease exceeded:

After 12/31/94 $15,500

After 12/ 31/93 but before 1/1/95 $14,600

After 12/31/92 but before 1/1/94 $14,300

After 12/ 31/91 but before 1/1/93 $13,700

If the lease term began before January 1, 1992,get Pub. 463, Travel, Entertainment, Gift, and CarExpenses, to find out if the corporation has aninclusion amount.

See Pub. 463 for instructions on figuringthe inclusion amount.

Line 12Taxes and Licenses

Enter taxes and licenses paid or incurred inthe trade or business activities of thecorporation, if not reflected in cost ofgoods sold. Federal import duties andFederal excise and stamp taxes aredeductible only if paid or incurred incarrying on the trade or business of thecorporation.

Do not deduct taxes, including state andlocal sales taxes, paid or accrued inconnection with the acquisition ordisposition of business property. Thesetaxes must be added to the cost of the

property, or in the case of a disposition,subtracted from the amount realized. Seesection 164.

Do not deduct taxes assessed againstlocal benefits that increase the value of theproperty assessed (such as for paving,etc.), Federal income taxes, or taxesreported elsewhere on the return.

Do not deduct section 901 foreign taxes.These taxes are reported separately on line15e, Schedule K.

Do not report on line 12 taxes allocableto portfolio income or to a rental activity.Taxes allocable to a rental real estateactivity are reported on Form 8825. Taxesallocable to a rental activity other than arental real estate activity are reported online 3b of Schedule K. Taxes allocable toportfolio income are reported on line 9 ofSchedules K and K-1.

Do not deduct on line 12 taxes paid orincurred for the production or collection ofincome, or for the management,conservation, or maintenance of propertyheld to produce income. Report thesetaxes separately on line 10 of Schedules Kand K-1.

See section 263A(a) for information oncapitalization of allocable costs (including

taxes) for any property.

Line 13Interest

Include on line 13 only interest incurred inthe trade or business activities of thecorporation that is not claimed elsewhereon the return.

Do not include interest expense on debtused to purchase rental property or debtused in a rental activity. Interest allocableto a rental real estate activity is reportedon Form 8825 and is used in arriving at netincome (loss) from rental real estateactivities on line 2 of Schedules K and K-1.Interest allocable to a rental activity otherthan a rental real estate activity is included

on line 3b of Schedule K and is used inarriving at net income (loss) from a rentalactivity (other than a rental real estateactivity). This net amount is reported online 3c of Schedule K and line 3 ofSchedule K-1.

Do not include interest expense clearlyand directly allocable to portfolio orinvestment income. This interest expenseis reported separately on line 11a ofSchedule K.

Do not include interest on debt proceedsallocated to distributions made toshareholders during the tax year. Instead,report such interest on line 10 ofSchedules K and K-1. To determine theamount to allocate to distributions toshareholders, see Notice 89-35, 1989-1C.B. 675.

Do not include interest expense on debtrequired to be allocated to the productionof qualified property. Interest allocable tocertain property produced by an Scorporation for its own use or for sale mustbe capitalized. The corporation must alsocapitalize any interest o