How to Analyze an 1120S Tax Return

The 1120S tax form is filed by companies known as S corporations, a particular type of corporation under the federal tax code. You can use the information in the tax returns they file to find out if businesses are profitable and how businesses and their owners are doing financially.

Understanding S Corporations and IRS Form 1120S

Under federal tax law, corporations are generally considered either S corporations or C corporations. Most big companies are classified as C corporations, and they file tax returns and pay taxes on their own and optionally disburse profits to stockholders in the form of dividends, who then pay taxes on those dividends themselves.

Some small businesses are instead classified as S corporations. They file an abbreviated tax return using the 1120S tax form, available from the Internal Revenue Service but do not pay income tax. Instead, their profits or losses are distributed among their shareholders in proportion to how much stock they own, and those shareholders then pay tax accordingly.

To be classified as an S corporation, each of a company's shareholders must agree in a filing with the IRS using tax form 2553. The company must also meet certain requirements, such as not having more than 100 shareholders, though relatives can sometimes be counted together, and not having corporations as shareholders. Limited liability companies, as defined under state law, aren't technically corporations but they can also opt to be taxed as S corporations if they meet the requirements.

S corporations then have to file a 1120S tax return every year. This form includes a variety of information that can be useful to anyone interested in understanding how the company is doing, whether as a shareholder, potential investor or business associate. It's a relatively simple tax form that includes information like the company's gross sales, cost of goods sold and expenses for costs like taxes, business licenses, advertising and salaries.

It also includes the company's total income or loss and some information on the company's assets and liabilities, which can be useful for understanding the company's debt-to-asset ratios and cash flow from year-to-year. For example, a company with a declining amount of cash or a high ratio of debt to assets may be a riskier investment than one with more cash on hand and fewer debts.

Consult the form 1120S instructions, available from the IRS, if you have any questions about what the entries on the form mean.

Notes and Exceptions

Comparing an S corporation's filings to other similar companies' information can also be useful to understand how a company is doing compared to its industry rivals. Since tax returns aren't public, this information isn't always easy to obtain, but a privately held S corporation can sometimes be compared to a publicly traded rival, which will release its financial information in Securities and Exchange Commission filings.

Naturally, having more years of tax returns will provide more information about how a company is doing. A company can switch from being a C corporation to being an S corporation or vice versa, assuming it meets S corporation requirements when doing so, and when it's a C corporation it will file different tax forms than IRS form 1120S.

the nest