Reflection of the Week 

 

Reviewing Your 1120 Return

Hey all. I hope you had a good week!

We’re officially two weeks away from the filing deadline for S-Corps. I’ve sent out a lot of 1120S drafts this week for review, so I figured I would provide some guidance on specific things you should look for. Getting a 70+ page document is intimidating, so hopefully, this guide helps make things more manageable. (And heads up, this might take more than five minutes.)

You may ask, shouldn’t my prepare already do this? Yes, he/she/they should review the return. And he/she/they will miss something. As perfect as we want to be (believe me, no one wants to be more perfect than me), we make mistakes. So, we also need your eyes to make sure we accomplish our joint goal of making your filing as easy and accurate as possible.

 

Verify your vitals

This check is the most important since this is how the IRS identifies who you are and matches other documents sent in your name, so don’t skip verifying the following at the top of your document:

• Name
• Address
• EIN
• Date of Incorporation
• S-Election date (make sure you can find your acceptance letter – CP261)
• And the number of shareholders (Line I)

Similarly, you will want to verify the same information for your shareholders:

• Name
• Address
• SSN
• Percentage of ownership

Again, we need your eyes. I’ve made several mistakes, like not using a client’s full name (e.g., Mark vs. Marcus), forgetting a suite number, or leaving off an ownership percentage. We can fix these mistakes afterward, but it’s much easier before we file the return.

 

Match your P&L and Balance Sheet with the return

Our tax returns and business financials are a check and balance system allowing us to spot problems and determine the source. The primary way to do this is to have your balance sheet and Profit and Loss with you as you check your returns.

You’ll start with income. Make sure the number on line 1a matches the total income on your Profit and Loss. Only report trade or business income, not interest, rental, portfolio, or tax-exempt income (that goes on your schedule K).

For the income and expenses, you’ll find many more separate categories on your profit and loss than on your return. The essential lines to verify are:

• Compensation of Officers (Line 7): As officers and owners, your wages should be separate from other employees’ wages (line 8). This line item becomes more critical when you have to match your individual K-1 information (more on that below).
• Total Deductions (Line 21): This number should be close to your total expenses at the bottom of your profit and loss. I say close because you can take some deductions on your profit and loss that you won’t be able to deduct on your tax return. For example, you can’t deduct charitable contributions (that goes on your Schedule K), and you only get half of your meal and entertainment expenses.

Your Schedule M-1 (Page 5 of the return) helps you reconcile your Profit and Loss with the return. Those numbers should match. And if they don’t, you should know why.

You’ll find the balance sheet information on your Schedule L (Page 4) of the return. Again, this information should match your accounting statements. Additionally, the total assets (line 15) should be the same as liabilities and shareholder equity (line 27). Lastly, the beginning of the tax year information should match the end-of-the-year information on your previous tax return.

You may have a tax preparer point out that you don’t need to provide a balance sheet if 1) the corporation’s total receipts are below $250,000 and 2) your total assets are below $250,000. While accurate, I recommend filing a balance sheet anyway. Your tax return will be a continuous record and story of your business. So, it’s crucial that you match the information from year to year and that information matches your accounting statements.

 

Review your personal income

Now that you’ve verified the business income, expenses, and balance sheet, you can now verify your portion of that money. You do that with the information on your K-1 and Form 7203.

If you’re the only shareholder, this part should be easy. On your K-1, the ordinary business income will be the same as the net profit from the business. If you’re one of multiple shareholders, you’ll need to divide the net income by the amount of shareholders (or ownership percentage if you are not equal shareholders). Similarly, you’ll verify the amounts in box 17 the same way when it comes to unallowable expenses like charitable contributions and disallowed meals.

Box 16 helps keep track of your basis. Basis has become a massive issue in the past couple of years for the IRS and was the impetus for the creation of Form 7203. Basis is a bit complex to discuss here, but, in short, it’s the amount that you’ve put into and taken out of the business. For your tax return purposes, you want to ensure line 16D (distributions) matches what you’ve taken out of the business. You’ll also find this amount on line 6 of your Form 7203.

As a side note, you’ll also see a Statement A on your K-1. This section is your share of entity information for your personal return. All the information will match the return if you’re the only shareholder. But, if you’re one of multiple, you’ll divide the total amount (Business income, W-2 wages, etc.) on the return by the number of shareholders (or by your specific ownership percentage, if that’s different). These amounts don’t correspond with what you were personally paid but rather your portion of the total income and expenses as a shareholder.

 

A few final thoughts

Despite having anxiety initially, my clients feel a bit of relief after getting some more awareness about their returns.

A few parting thoughts from some previous experience

• Don’t put too much pressure on yourself: This is not about perfection or catching every mistake your tax preparer makes. As I said, we all make mistakes. I still make a fair share, and I’ve been in the business for 20 years. It’s a complicated system that continually changes, and we’re all doing the best we can with the information we have. So don’t beat yourself up if you’re now finding mistakes you or your tax professional made.
• Trust your gut: That being said, some mistakes are more significant than others. I’ve talked to several clients who knew something wasn’t quite right with their previous tax professionals. For example, one preparer completely transposed another client’s information onto my client’s return. Trust and investigate your feelings. Get a second opinion. You may find that everything is correct. Or you may find a lot of big gaps, which means you have what you need to find another preparer.
• Ask questions: Above all, ask questions. You don’t necessarily need to know or learn all the nuances, but ask what you need to make sure you have a good understanding of your business, including its balance sheet or profit and loss. You and your preparer are on the same team, so hopefully they will welcome and appreciate your questions.

I hope you found this helpful. I’ve also done a deep dive on my podcast if you find yourself inspired to learn more.

 

Questions of the week?

• Do you have a copy of your return?
• Do you have anxiety over reviewing it?
• What simple thing can you review to get started?

 

Reminder of the Week

If you’re an S-Corp owner or a part of a partnership, you have two weeks (3/15) to submit your return. Get to it!