Instructions for Form 1120S (2007)

IRS Resources

Specific Instructions

Table of Contents

Period Covered

File the 2007 return for calendar year 2007 and fiscal years that begin in 2007 and end in 2008. For a fiscal or short tax year return, fill in the tax year space at the top of the form.

The 2007 Form 1120S can also be used if:

The corporation has a tax year of less than 12 months that begins and ends in 2008, and
The 2008 Form 1120S is not available at the time the corporation is required to file its return.

The corporation must show its 2008 tax year on the 2007 Form 1120S and take into account any tax law changes that are effective for tax years beginning after December 31, 2007.

Name and Address

Enter the corporation's true name (as set forth in the charter or other legal document creating it), address, and EIN on the appropriate lines. Enter the address of the corporation's principal office or place of business. Include the suite, room, or other unit number after the street address. If the post office does not deliver mail to the street address and the corporation has a P.O. box, show the box number instead.

Note.

Do not use the address of the registered agent for the state in which the corporation is incorporated. For example, if a business is incorporated in Delaware or Nevada and the corporation's principal office is located in Little Rock, AR, the corporation should enter the Little Rock address.

If the corporation receives its mail in care of a third party (such as an accountant or an attorney), enter on the street address line “C/O” followed by the third party's name and street address or P.O. box.

If the corporation received a Form 1120S tax package, use the preprinted label. Cross out any errors and print the correct information on the label.

Item B. Business Code

See the Principal Business Activity Codes on pages 38 through 40 of these instructions.

Item C. Schedule M-3 Information

A corporation with total assets of $10 million or more on the last day of the tax year must complete Schedule M-3 (Form 1120S), Net Income (Loss) Reconciliation for S Corporations With Total Assets of $10 Million or More, instead of Schedule M-1. A corporation filing Form 1120S that is not required to file Schedule M-3 may voluntarily file Schedule M-3 instead of Schedule M-1.

If you are filing Schedule M-3, check the “Check if Sch. M-3 attached” box. See the Instructions for Schedule M-3 for more details.

Item D. Employer Identification Number (EIN)

Enter the corporation's EIN. If the corporation does not have an EIN, it must apply for one. An EIN can be applied for:

Online—Click on the EIN link at www.irs.gov/businesses/small. The EIN is issued immediately once the application information is validated.
By telephone at 1-800-829-4933 from 7:00 a.m. to 10:00 p.m. in the corporation's local time zone.
By mailing or faxing Form SS-4, Application for Employer Identification Number.

If the corporation has not received its EIN by the time the return is due, enter “Applied for” and the date you applied in the space for the EIN. For more details, see the Instructions for Form SS-4.

Item F. Total Assets

Enter the corporation's total assets (as determined by the accounting method regularly used in keeping the corporation's books and records) at the end of the tax year. If there were no assets at the end of the tax year, enter -0-.

If the corporation is required to complete Schedule L, enter total assets from Schedule L, line 15, column (d) on page 1, item F. If the S election terminated during the tax year, see the instructions for Schedule L on page 34 for special rules that may apply when figuring the corporation's year-end assets.

Item H. Final Return, Name Change, Address Change, Amended Return, or S Election Termination or Revocation

If this is the corporation's final return and it will no longer exist, check the “Final return” box. Also check the “Final K-1” box on each Schedule K-1.
If the corporation changed its name since it last filed a return, check the “Name change” box. Generally, a corporation also must have amended its articles of incorporation and filed the amendment with the state in which it was incorporated.
If the corporation has changed its address since it last filed a return (including a change to an “in care of” address), check the “Address change” box. If a change in address occurs after the return is filed, use Form 8822, Change of Address, to notify the IRS of the new address.
If this amends a previously filed return, check the “Amended return” box. If Schedules K-1 are also being amended, check the “Amended K-1” box on each Schedule K-1.
If the corporation has terminated or revoked its S election, check the “S election termination or revocation” box. See Termination of Election on page 2.

Income

Report only trade or business activity income on lines 1a through 6. Do not report rental activity income or portfolio income on these lines. See Passive Activity Limitations beginning on page 6 for definitions of rental income and portfolio income. Rental activity income and portfolio income are reported on Schedules K and K-1. Rental real estate activities are also reported on Form 8825.

Tax-exempt income. Do not include any tax-exempt income on lines 1a through 5. A corporation that receives any tax-exempt income other than interest, or holds any property or engages in any activity that produces tax-exempt income, reports this income on line 16b of Schedule K and in box 16 of Schedule K-1 using code B.

Report tax-exempt interest income, including exempt-interest dividends received as a shareholder in a mutual fund or other regulated investment company, on line 16a of Schedule K and in box 16 of Schedule K-1 using code A.

See Deductions on page 13 for information on how to report expenses related to tax-exempt income.

Cancelled debt exclusion. If the corporation has had debt discharged resulting from a title 11 bankruptcy proceeding or while insolvent, see Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment), and Pub. 908, Bankruptcy Tax Guide.

Line 1. Gross Receipts or Sales

Enter gross receipts or sales from all business operations except those that must be reported on lines 4 and 5.

In general, advance payments are reported in the year of receipt. To report income from long-term contracts, see section 460. For special rules for reporting certain advance payments for goods and long-term contracts, see Regulations section 1.451-5. For permissible methods for reporting advance payments for services and certain goods by an accrual method corporation, see Rev. Proc. 2004-34, 2004-22 I.R.B. 991.

Installment sales. Generally, the installment method cannot be used for dealer dispositions of property. A “dealer disposition” is any disposition of: (a) personal property by a person who regularly sells or otherwise disposes of personal property of the same type on the installment plan or (b) real property held for sale to customers in the ordinary course of the taxpayer's trade or business.

These restrictions on using the installment method do not apply to dispositions of property used or produced in a farming business or sales of timeshares and residential lots for which the corporation elects to pay interest under section 453(l)(3).

For sales of timeshares and residential lots reported under the installment method, each shareholder's income tax is increased by the shareholder's pro rata share of the interest payable under section 453(l)(3).

Enter on line 1a the gross profit on collections from installment sales for any of the following.

Dealer dispositions of property before March 1, 1986.
Dispositions of property used or produced in the trade or business of farming.
Certain dispositions of timeshares and residential lots reported under the installment method.

Attach a statement showing the following information for the current and the 3 preceding years: (a) gross sales, (b) cost of goods sold, (c) gross profits, (d) percentage of gross profits to gross sales, (e) amount collected, and (f) gross profit on the amount collected.

Line 2. Cost of Goods Sold

See the Schedule A instructions on page 18.

Line 4. Net Gain (Loss) From Form 4797

Include only ordinary gains or losses from the sale, exchange, or involuntary conversion of assets used in a trade or business activity. Ordinary gains or losses from the sale, exchange, or involuntary conversion of rental activity assets are reported separately on line 19 of Form 8825 or line 3 of Schedule K and box 3 of Schedule K-1, generally as a part of the net income (loss) from the rental activity.

A corporation that is a partner in a partnership must include on Form 4797, Sales of Business Property, its share of ordinary gains (losses) from sales, exchanges, or involuntary conversions (other than casualties or thefts) of the partnership's trade or business assets.

Corporations should not use Form 4797 to report the sale or other disposition of property if a section 179 expense deduction was previously passed through to any of its shareholders for that property. Instead, report it in box 17 of Schedule K-1 using code K. See the instructions on page 33 for Dispositions of property with section 179 deductions (code K), for details.

Line 5. Other Income (Loss)

Enter any other trade or business income (loss) not included on lines 1a through 4. List the type and amount of income on an attached statement.

Examples of other income include the following.

Interest income derived in the ordinary course of the corporation's trade or business, such as interest charged on receivable balances. See Temporary Regulations section 1.469-2T(c)(3).
Recoveries of bad debts deducted in prior years under the specific charge-off method.
Taxable income from insurance proceeds.
The amount included in income from line 4 of Form 6478, Credit for Alcohol Used as Fuel.
The amount included in income from line 8 of Form 8864, Biodiesel and Renewable Diesel Fuels Credit.
The recapture amount under section 280F if the business use of listed property drops to 50% or less. To figure the recapture amount, complete Part IV of Form 4797.
Any recapture amount under section 179A for certain clean-fuel vehicle property (or clean-fuel vehicle refueling property) that ceases to qualify. See Regulations section 1.179A-1 for details.
All section 481 income adjustments resulting from changes in accounting methods. Show the computation of the section 481 adjustments on an attached statement.
Part or all of the proceeds received from certain corporate-owned life insurance contracts issued after August 17, 2006. See section 101(j) for details.

Do not include items requiring separate computations by shareholders that must be reported on Schedules K and K-1. See the instructions for Schedules K and K-1 later in these instructions.

Ordinary Income (Loss) From a Partnership, Estate, or Trust

Enter the ordinary income (loss) shown on Schedule K-1 (Form 1065) or Schedule K-1 (Form 1041), or other ordinary income (loss) from a foreign partnership, estate, or trust. Show the partnership's, estate's, or trust's name, address, and EIN on a separate statement attached to this return. If the amount entered is from more than one source, identify the amount from each source.

Do not include portfolio income or rental activity income (loss) from a partnership, estate, or trust on this line. Instead, report these amounts on Schedules K and K-1, or on line 20a of Form 8825 if the amount is from a rental real estate activity.

Ordinary income or loss from a partnership that is a publicly traded partnership is not reported on this line. Instead, report the amount separately on line 10 of Schedule K and in box 10 of Schedule K-1 using code E.

Treat shares of other items separately reported on Schedule K-1 issued by the other entity as if the items were realized or incurred by this corporation.

If there is a loss from a partnership, the amount of the loss that may be claimed is subject to the at-risk and basis limitations as appropriate.

If the tax year of the S corporation does not coincide with the tax year of the partnership, estate, or trust, include the ordinary income (loss) from the other entity in the tax year in which the other entity's tax year ends.

Deductions

Report only trade or business activity deductions on lines 7 through 19.

Do not report the following expenses on lines 7 through 19.

Rental activity expenses. Report these expenses on Form 8825 or line 3b of Schedule K.
Deductions allocable to portfolio income. Report these deductions on line 12d of Schedule K and in box 12 of Schedule K-1 using code H, J, or K.
Nondeductible expenses (for example, expenses connected with the production of tax-exempt income). Report nondeductible expenses on line 16c of Schedule K and in box 16 of Schedule K-1 using code C.
Qualified expenditures to which an election under section 59(e) may apply. The instructions for line 12c of Schedule K and for Schedule K-1, box 12, code I, explain how to report these amounts.
Items the corporation must state separately that require separate computations by the shareholders. Examples include expenses incurred for the production of income instead of in a trade or business, charitable contributions, foreign taxes paid or accrued, intangible drilling and development costs, soil and water conservation expenditures, amortizable basis of reforestation expenditures, and exploration expenditures. The pro rata shares of these expenses are reported separately to each shareholder on Schedule K-1.

Limitations on Deductions

Section 263A uniform capitalization rules. The uniform capitalization rules of section 263A generally require corporations to capitalize, or include in inventory, certain costs incurred in connection with the following.

The production of real property and tangible personal property held in inventory or held for sale in the ordinary course of business.
Real property or personal property (tangible and intangible) acquired for resale.
The production of real property and tangible personal property by a corporation for use in its trade or business or in an activity engaged in for profit.

Tangible personal property produced by a corporation includes a film, sound recording, videotape, book, or similar property.

The costs required to be capitalized under section 263A are not deductible until the property to which the costs relate is sold, used, or otherwise disposed of by the corporation.

Exceptions. Section 263A does not apply to the following.

Inventoriable items accounted for in the same manner as materials and supplies that are not incidental. See Schedule A. Cost of Goods Sold on page 18 for details.
Personal property acquired for resale if the corporation's (or any predecessor's) average annual gross receipts for the 3 prior tax years were $10 million or less.
Timber.
Most property produced under a long-term contract.
Certain property produced in a farming business. See Special rules for certain corporations engaged in farming on page 14.
Geological and geophysical costs amortized under section 167(h).
Capital costs incurred to comply with EPA sulfur regulations.

The corporation must report the following costs separately to the shareholders for purposes of determinations under section 59(e).

Research and experimental costs under section 174.
Intangible drilling costs for oil, gas, and geothermal property.
Mining exploration and development costs.

Indirect costs. Corporations subject to the uniform capitalization rules are required to capitalize not only direct costs but an allocable part of most indirect costs (including taxes) that benefit the assets produced or acquired for resale, or are incurred because of the performance of production or resale activities.

For inventory, some of the indirect costs that must be capitalized are:

Administration expenses;
Taxes;
Depreciation;
Insurance;
Compensation paid to officers attributable to services;
Rework labor; and
Contributions to pension, stock bonus, and certain profit-sharing, annuity, or deferred compensation plans.

Regulations section 1.263A-1(e)(3) specifies other indirect costs that relate to production or resale activities that must be capitalized and those that may be currently deductible.

Interest expense paid or incurred during the production period of designated property must be capitalized and is governed by special rules. For more details, see Regulations sections 1.263A-8 through 1.263A-15.

For more details on the uniform capitalization rules, see Regulations sections 1.263A-1 through 1.263A-3.

Special rules for certain corporations engaged in farming. For S corporations not required to use the accrual method of accounting, the rules of section 263A do not apply to expenses of raising any:

Animal or
Plant that has a preproductive period of 2 years or less.

Shareholders of S corporations not required to use the accrual method of accounting may elect to currently deduct the preproductive period expenses of certain plants that have a preproductive period of more than 2 years. Because each shareholder makes the election to deduct these expenses, the corporation should not capitalize them. Instead, the corporation should report the expenses separately on line 12d of Schedule K and report each shareholder's pro rata share in box 12 of Schedule K-1 using code L.

See Uniform Capitalization Rules in chapter 6 of Pub. 225, Farmer's Tax Guide, sections 263A(d) and (e), and Regulations section 1.263A-4 for definitions and other details.

Transactions between related taxpayers. Generally, an accrual basis S corporation can deduct business expenses and interest owed to a related party (including any shareholder) only in the tax year of the corporation that includes the day on which the payment is includible in the income of the related party. See section 267 for details.

Section 291 limitations. If the S corporation was a C corporation for any of the 3 immediately preceding years, the corporation may be required to adjust deductions for depletion of iron ore and coal, and the amortizable basis of pollution control facilities. If this applies, see section 291 to figure the adjustment.

Business start-up and organizational costs. Business start-up and organizational costs must be capitalized unless an election is made to deduct or amortize them. For costs paid or incurred after October 22, 2004, the following rules apply separately to each category of costs.

The corporation can elect to deduct up to $5,000 of such costs for the year the corporation begins business operations.
The $5,000 deduction is reduced (but not below zero) by the amount the total costs exceed $50,000. If the total costs are $55,000 or more, the deduction is reduced to zero.
If the election is made, any costs that are not deducted must be amortized ratably over a 180-month period.

For costs paid or incurred before October 23, 2004, the corporation can elect to amortize the costs over a period of 60 months or more.

In all cases, the amortization period begins the month the corporation begins business operations. For more details on the election, see Pub. 535.

Attach any statement required by Regulations sections 1.195-1(b) or 1.248-1(c). Report the deductible amount of these costs and any amortization on line 19. For amortization that begins during the 2007 tax year, complete and attach Form 4562.

Reducing certain expenses for which credits are allowable. If the corporation claims a credit on any of the following forms, it may need to reduce the otherwise allowable deductions for expenses used to figure the credit.

Form 5884, Work Opportunity Credit.
Form 6765, Credit for Increasing Research Activities.
Form 8820, Orphan Drug Credit.
Form 8826, Disabled Access Credit.
Form 8844, Empowerment Zone and Renewal Community Employment Credit.
Form 8845, Indian Employment Credit.
Form 8846, Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips.
Form 8861, Welfare-to-Work Credit.
Form 8881, Credit for Small Employer Pension Plan Startup Costs.
Form 8882, Credit for Employer-Provided Childcare Facilities and Services.
Form 8896, Low Sulfur Diesel Fuel Production Credit.
Form 8923, Mine Rescue Team Training Credit.

If the corporation has any of these credits, figure each current year credit before figuring the deduction for expenses on which the credit is based. See the instructions for the form used to figure the credit for details.

Line 7. Compensation of Officers and Line 8. Salaries and Wages

Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.

Enter on line 7 the total compensation of all officers paid or incurred in the trade or business activities of the corporation. The corporation determines who is an officer under the laws of the state where it is incorporated.

Enter on line 8 the total salaries and wages paid or incurred to employees (other than officers) during the tax year.

If the corporation claims a credit for any wages paid or incurred, it may need to reduce the amounts on lines 7 and 8. See Reducing certain expenses for which credits are allowable on this page for details.

Do not include salaries and wages reported elsewhere on the return, such as amounts included in cost of goods sold, elective contributions to a section 401(k) cash or deferred arrangement, or amounts contributed under a salary reduction SEP agreement or a SIMPLE IRA plan.

Include fringe benefit expenditures made on behalf of officers and employees owning more than 2% of the corporation's stock. Also report these fringe benefits as wages in box 1 of Form W-2. Do not include amounts paid or incurred for fringe benefits of officers and employees owning 2% or less of the corporation's stock. These amounts are reported on line 18. See the instructions for that line for information on the types of expenditures that are treated as fringe benefits and for the stock ownership rules.

Report amounts paid for health insurance coverage for a more than 2% shareholder (including that shareholder's spouse and dependents) as an information item in box 14 of that shareholder's Form W-2. A more-than-2% shareholder may be allowed to deduct such amounts on Form 1040, line 29.

If a shareholder or a member of the family of one or more shareholders of the corporation renders services or furnishes capital to the corporation for which reasonable compensation is not paid, the IRS may make adjustments in the items taken into account by such individuals to reflect the value of such services or capital. See section 1366(e).

Line 9. Repairs and Maintenance

Enter the cost of incidental repairs and maintenance not claimed elsewhere on the return, such as labor and supplies, that do not add to the value of the property or appreciably prolong its life. The corporation can deduct these repairs only to the extent they relate to a trade or business activity. New buildings, machinery, or permanent improvements that increase the value of the property are not deductible. They must be depreciated or amortized.

Line 10. Bad Debts

Enter the total debts that became worthless in whole or in part during the tax year, but only to the extent such debts relate to a trade or business activity. Report deductible nonbusiness bad debts as a short-term capital loss on Schedule D (Form 1120S), Capital Gains and Losses and Built-In Gains. A cash method taxpayer cannot claim a bad debt deduction unless the amount was previously included in income.

Line 11. Rents

Enter rent paid on business property used in a trade or business activity. Do not deduct rent for a dwelling unit occupied by any shareholder for personal use.

If the corporation rented or leased a vehicle, enter the total annual rent or lease expense paid or incurred in the trade or business activities of the corporation during the tax year. Also complete Part V of Form 4562, Depreciation and Amortization. If the corporation leased a vehicle for a term of 30 days or more, the deduction for vehicle lease expense may have to be reduced by an amount called the inclusion amount. The corporation may have an inclusion amount if:

The lease term began:	And the vehicle's FMV on the first day of the lease exceeded:
After 12/31/06 but before 1/1/08	$15,500
After 12/31/04 but before 1/1/07	$15,200
After 12/31/03 but before 1/1/05	$17,500
If the lease term began before January 1, 2004, see Pub. 463, Travel, Entertainment, Gift, and Car Expenses, to find out if the corporation has an inclusion amount. The inclusion amount for lease terms beginning in 2008 will be published in the Internal Revenue Bulletin in early 2008.

See Pub. 463 for instructions on figuring the inclusion amount.

Line 12. Taxes and Licenses

Enter taxes and licenses paid or incurred in the trade or business activities of the corporation, unless they are reflected elsewhere on the return. Federal import duties and federal excise and stamp taxes are deductible only if paid or incurred in carrying on the trade or business of the corporation.

Do not deduct the following taxes on line 12.

Federal income taxes (except for the portion of built-in gains tax allocable to ordinary income), or taxes reported elsewhere on the return.
Section 901 foreign taxes. Report these taxes on line 14l of Schedule K and in box 14 of Schedule K-1 using codes L and M.
Taxes allocable to a rental activity. Taxes allocable to a rental real estate activity are reported on Form 8825. Taxes allocable to a rental activity other than a rental real estate activity are reported on line 3b of Schedule K.
Taxes allocable to portfolio income. Report these taxes on line 12d of Schedule K and in box 12 of Schedule K-1 using code J.
Taxes paid or incurred for the production or collection of income, or for the management, conservation, or maintenance of property held to produce income. Report these taxes separately on line 12d of Schedule K and in box 12 of Schedule K-1 using code R.

See section 263A(a) for rules on capitalization of allocable costs (including taxes) for any property.

Taxes not imposed on the corporation.
Taxes, including state or local sales taxes, that are paid or incurred in connection with an acquisition or disposition of property (these taxes must be treated as a part of the cost of the acquired property or, in the case of a disposition, as a reduction in the amount realized on the disposition).
Taxes assessed against local benefits that increase the value of the property assessed (such as for paving, etc.).

See section 164(d) for apportionment of taxes on real property between seller and purchaser.

Line 13. Interest

Include only interest incurred in the trade or business activities of the corporation that is not claimed elsewhere on the return.

Do not include interest expense:

On debt used to purchase rental property or debt used in a rental activity. Interest allocable to a rental real estate activity is reported on Form 8825 and is used in arriving at net income (loss) from rental real estate activities on line 2 of Schedule K and in box 2 of Schedule K-1. Interest allocable to a rental activity other than a rental real estate activity is included on line 3b of Schedule K and is used in arriving at net income (loss) from a rental activity (other than a rental real estate activity). This net amount is reported on line 3c of Schedule K and in box 3 of Schedule K-1.
On debt used to buy property held for investment. Interest that is clearly and directly allocable to interest, dividend, royalty, or annuity income not derived in the ordinary course of a trade or business is reported on line 12b of Schedule K and in box 12 of Schedule K-1 using code G. See the instructions for line 12b of Schedule K, for box 12, code G of Schedule K-1, and Form 4952, Investment Interest Expense Deduction, for more information on investment property.
On debt proceeds allocated to distributions made to shareholders during the tax year. Instead, report such interest on line 12d of Schedule K and in box 12 of Schedule K-1 using code R. To determine the amount to allocate to distributions to shareholders, see Notice 89-35, 1989-1 C.B. 675.
On debt required to be allocated to the production of designated property. Designated property includes real property, personal property that has a class life of 20 years or more, and other tangible property requiring more than 2 years (1 year in the case of property with a cost of more than $1 million) to produce or construct. Interest allocable to designated property produced by a corporation for its own use or for sale must be capitalized. In addition, a corporation must also capitalize any interest on debt allocable to an asset used to produce designated property. A shareholder may have to capitalize interest that the shareholder incurs during the tax year for the S corporation's production expenditures. Similarly, interest incurred by an S corporation may have to be capitalized by a shareholder for the shareholder's own production expenditures. The information required by the shareholder to properly capitalize interest for this purpose must be provided by the corporation on an attachment for box 17 of Schedule K-1 using code P. See section 263A(f) and Regulations sections 1.263A-8 through 1.263A-15.

Special rules apply to:

Allocating interest expense among activities so that the limitations on passive activity losses, investment interest, and personal interest can be properly figured. Generally, interest expense is allocated in the same manner as debt is allocated. Debt is allocated by tracing disbursements of the debt proceeds to specific expenditures. Temporary Regulations section 1.163-8T gives rules for tracing debt proceeds to expenditures.
Prepaid interest, which generally can only be deducted over the period to which the prepayment applies. See section 461(g) for details.
Interest which is allocable to unborrowed policy cash values of life insurance, endowment, or annuity contracts issued after June 8, 1997. See section 264(f). Attach a statement showing the computation of the deduction.

Line 14. Depreciation

Enter the depreciation claimed on assets used in a trade or business activity less any depreciation reported elsewhere on the return (for example, on Schedule A). See the Instructions for Form 4562 or Pub. 946, How To Depreciate Property, to figure the amount of depreciation to enter on this line.

Complete and attach Form 4562 only if the corporation placed property in service during the tax year or claims depreciation on any car or other listed property. There is different treatment for property located in a GO Zone. See the Instructions for Form 4562 for details.

Do not include any section 179 expense deduction on this line. This amount is not deducted by the corporation. Instead, it is passed through to the shareholders in box 11 of Schedule K-1.

Line 15. Depletion

If the corporation claims a deduction for timber depletion, complete and attach Form T (Timber), Forest Activities Schedule.

Do not deduct depletion for oil and gas properties. Each shareholder figures depletion on oil and gas properties. See the instructions for Schedule K-1, box 17, code R, for the information on oil and gas depletion that must be supplied to the shareholders by the corporation.

Line 17. Pension, Profit-Sharing, etc., Plans

Enter the deductible contributions not claimed elsewhere on the return made by the corporation for its employees under a qualified pension, profit-sharing, annuity, or simplified employee pension (SEP) or SIMPLE plan, or any other deferred compensation plan.

If the corporation contributes to an individual retirement arrangement (IRA) for employees, include the contribution in salaries and wages on page 1, line 8, or Schedule A, line 3, and not on line 17.

Employers who maintain a pension, profit-sharing, or other funded deferred compensation plan, whether or not the plan is qualified under the Internal Revenue Code and whether or not a deduction is claimed for the current tax year, generally must file the applicable form listed below.

Form 5500, Annual Return/Report of Employee Benefit Plan. File this form for a plan that is not a one-participant plan.
Form 5500-EZ, Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan. File this form for a plan that only covers the owner (or the owner and his or her spouse) but only if the owner (or the owner and his or her spouse) owns the entire business.

There are penalties for not filing these forms on time and for overstating the pension plan deduction. See sections 6652(e) and 6662(f).

Line 18. Employee Benefit Programs

Enter amounts for fringe benefits paid or incurred on behalf of employees owning 2% or less of the corporation's stock. These fringe benefits include (a) employer contributions to certain accident and health plans, (b) the cost of up to $50,000 of group-term life insurance on an employee's life, and (c) meals and lodging furnished for the employer's convenience.

Do not deduct amounts that are an incidental part of a pension, profit-sharing, etc., plan included on line 17 or amounts reported elsewhere on the return.

Report amounts for fringe benefits paid on behalf of employees owning more than 2% of the corporate stock on line 7 or 8, whichever applies. An employee is considered to own more than 2% of the corporation's stock if that person owns on any day during the tax year more than 2% of the outstanding stock of the corporation or stock possessing more than 2% of the combined voting power of all stock of the corporation. See section 318 for attribution rules.

Line 19. Other Deductions

Enter the total allowable trade or business deductions that are not deductible elsewhere on page 1 of Form 1120S. Attach a statement listing by type and amount each deduction included on this line.

Examples of other deductions include the following.

Amortization. See Part VI of Form 4562.
Certain business start-up and organizational costs the corporation elects to deduct. See page 14.
Insurance premiums.
Legal and professional fees.
Supplies used and consumed in the business.
Travel, meal, and entertainment expenses. Special rules apply (discussed below).
Utilities.
Deduction for certain energy efficient commercial building property. See section 179D and Notice 2006-52, 2006-26 I.R.B. 1175.
Any negative net section 481(a) adjustment.

Do not deduct the following on line 19.

Items that must be reported separately on Schedules K and K-1.
Fines or penalties paid to a government for violating any law. Report these expenses on Schedule K, line 16c.
Expenses allocable to tax-exempt income. Report these expenses on Schedule K, line 16c.

Special Rules

Commercial revitalization deduction. If the corporation constructs, purchases, or substantially rehabilitates a qualified building in a renewal community, it may qualify for a deduction of either (a) 50% of qualified capital expenditures in the year the building is placed in service or (b) amortization of 100% of the qualified capital expenditures over a 120-month period beginning with the month the building is placed in service. If the corporation elects to amortize these expenditures, complete and attach Form 4562. To qualify, the building must be nonresidential (as defined in section 168(e)(2)) and placed in service by the corporation. The corporation must be the original user of the building unless it is substantially rehabilitated. The qualified expenditures cannot exceed the lesser of $10 million or the amount allocated to the building by the commercial revitalization agency of the state in which the building is located. Any remaining expenditures are depreciated over the regular depreciation recovery period. See Pub. 954, Tax Incentives for Distressed Communities, and section 1400I for details.

Rental real estate. Do not report this deduction on line 19 if the building is placed in service as rental real estate. A commercial revitalization deduction for rental real estate is not deducted by the corporation but is passed through to the shareholders in box 12 of Schedule K-1 using code M.

Travel, meals, and entertainment. Subject to limitations and restrictions discussed below, a corporation can deduct ordinary and necessary travel, meals, and entertainment expenses paid or incurred in its trade or business. Also, special rules apply to deductions for gifts, skybox rentals, luxury water travel, convention expenses, and entertainment tickets. See section 274 and Pub. 463 for details.

Travel. The corporation cannot deduct travel expenses of any individual accompanying a corporate officer or employee, including a spouse or dependent of the officer or employee, unless:

That individual is an employee of the corporation, and
His or her travel is for a bona fide business purpose and would otherwise be deductible by that individual.

Meals and entertainment. Generally, the corporation can deduct only 50% of the amount otherwise allowable for meals and entertainment expenses paid or incurred in its trade or business. In addition (subject to exceptions under section 274(k)(2)):

Meals must not be lavish or extravagant;
A bona fide business discussion must occur during, immediately before, or immediately after the meal; and
An employee of the corporation must be present at the meal.

See section 274(n)(3) for a special rule that applies to expenses for meals consumed by individuals subject to the hours of service limits of the Department of Transportation.

Membership dues. The corporation can deduct amounts paid or incurred for membership dues in civic or public service organizations, professional organizations (such as bar and medical associations), business leagues, trade associations, chambers of commerce, boards of trade, and real estate boards. However, no deduction is allowed if a principal purpose of the organization is to entertain, or provide entertainment facilities for, members or their guests. In addition, corporations cannot deduct membership dues in any club organized for business, pleasure, recreation, or other social purpose. This includes country clubs, golf and athletic clubs, airline and hotel clubs, and clubs operated to provide meals under conditions favorable to business discussion.

Entertainment facilities. The corporation cannot deduct an expense paid or incurred for a facility (such as a yacht or hunting lodge) used for an activity usually considered entertainment, amusement, or recreation.

Amounts treated as compensation. The corporation may be able to deduct otherwise nondeductible entertainment, amusement, or recreation expenses if the amounts are treated as compensation to the recipient and reported on Form W-2 for an employee or on Form 1099-MISC for an independent contractor.

However, if the recipient is an officer, director, or beneficial owner (directly or indirectly) of more than 10% of the corporation's stock, the deductible expense is limited. See section 274(e)(2) and Notice 2005-45, 2005-24 I.R.B. 1228.

Lobbying expenses. Generally, lobbying expenses are not deductible. Report nondeductible expenses on Schedule K, line 16c. These expenses include:

Amounts paid or incurred in connection with influencing federal or state legislation (but not local legislation) or
Amounts paid or incurred in connection with any communication with certain federal executive branch officials in an attempt to influence the official actions or positions of the officials. See Regulations section 1.162-29 for the definition of “influencing legislation.”

Dues and other similar amounts paid to certain tax-exempt organizations may not be deductible. See section 162(e)(3). If certain in-house lobbying expenditures do not exceed $2,000, they are deductible. For information on contributions to charitable organizations that conduct lobbying activities, see section 170(f)(9).

Certain corporations engaged in farming. Section 464(f) limits the deduction for certain expenditures of S corporations engaged in farming if they use the cash method of accounting, and their prepaid farm supplies are more than 50% of other deductible farming expenses.

Prepaid farm supplies include expenses for feed, seed, fertilizer, and similar farm supplies not used or consumed during the year. They also include the cost of poultry that would be allowable as a deduction in a later tax year if the corporation were to (a) capitalize the cost of poultry bought for use in its farm business and deduct it ratably over the lesser of 12 months or the useful life of the poultry and (b) deduct the cost of poultry bought for resale in the year it sells or otherwise disposes of it.

If the limit applies, the corporation can deduct prepaid farm supplies that do not exceed 50% of its other deductible farm expenses in the year of payment. The excess is deductible only in the year the corporation uses or consumes the supplies (other than poultry, which is deductible as explained above). For exceptions and more details on these rules, see Pub. 225.

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Excess net passive income tax worksheet

Reforestation expenditures. If the corporation made an election to deduct a portion of its reforestation expenditures on line 12d of Schedule K, it must amortize over an 84-month period the portion of these expenditures in excess of the amount deducted on Schedule K (see section 194). Deduct on line 19 only the amortization of these excess reforestation expenditures. See Reforestation expense deduction (code N) on page 26.

Do not deduct amortization of reforestation expenditures paid or incurred before October 23, 2004. If the corporation elected to amortize these expenditures, report the amortizable basis on line 17d of Schedule K. See Amortization of reforestation costs (code S) on page 34 for details.

Line 21. Ordinary Business Income (Loss)

Enter this income or loss on line 1 of Schedule K. Line 21 income is not used in figuring the excess net passive income or built-in gains taxes. See the instructions for line 22a for figuring taxable income for purposes of these taxes.

Tax and Payments

Line 22a. Excess Net Passive Income and LIFO Recapture Tax

These taxes can apply if the corporation was previously a C corporation or if the corporation engaged in a tax-free reorganization with a C corporation.

Excess net passive income tax. If the corporation has accumulated earnings and profits (AE&P) at the close of its tax year, has passive investment income for the tax year that is in excess of 25% of gross receipts, and has taxable income at year-end, the corporation must pay a tax on the excess net passive income. Complete lines 1 through 3 and line 9 of the worksheet on page 17 to make this determination. If line 2 is greater than line 3 and the corporation has taxable income (see instructions for line 9 of the worksheet), it must pay the tax. Complete a separate schedule using the format of lines 1 through 11 of the worksheet to figure the tax. Enter the tax on line 22a, page 1, Form 1120S, and attach the computation schedule to Form 1120S.

Reduce each item of passive income passed through to shareholders by its portion of any excess net passive income tax reported on line 22a. See section 1366(f)(3).

LIFO recapture tax. The corporation may be liable for the additional tax due to LIFO recapture under Regulations section 1.1363-2 if:

The corporation used the LIFO inventory pricing method for its last tax year as a C corporation, or
A C corporation transferred LIFO inventory to the corporation in a nonrecognition transaction in which those assets were transferred basis property.

The additional tax due to LIFO recapture is figured for the corporation's last tax year as a C corporation or for the tax year of the transfer, whichever applies. See the Instructions for Form 1120 to figure the tax.

The tax is paid in four equal installments. The C corporation must pay the first installment by the due date (not including extensions) of Form 1120 for the corporation's last tax year as a C corporation or for the tax year of the transfer, whichever applies. The S corporation must pay each of the remaining installments by the due date (not including extensions) of Form 1120S for the 3 succeeding tax years. Include this year's installment in the total amount to be entered on line 22a. To the left of the total on line 22a, enter the installment amount and “LIFO tax.”

Line 22b. Tax From Schedule D (Form 1120S)

Enter the built-in gains tax from line 21 of Part III of Schedule D. See the instructions for Part III of Schedule D to determine if the corporation is liable for the tax.

Line 22c

Include the following in the total for line 22c.

Investment credit recapture tax. The corporation is liable for investment credit recapture attributable to credits allowed for tax years for which the corporation was not an S corporation. Figure the corporation's investment credit recapture tax by completing Form 4255, Recapture of Investment Credit.

To the left of the line 22c total, enter the amount of recapture tax and “Tax From Form 4255.” Attach Form 4255 to Form 1120S.

Interest due under the look-back method for completed long-term contracts. If the corporation owes this interest, attach Form 8697. To the left of the total on line 22c, enter the amount owed and “From Form 8697.”