Small businesses organized as S corporations must meet qualifications under federal tax laws, including offering only one type of stock and including no more than 100 shareholders as part of the corporation. All shareholders must agree to the S corporation organization for the year, but holders can remove the S corporation designation at any time by a vote of the corporate membership. Evaluating the financial health of an S corporation involves examining the tax forms filed annually with the Internal Revenue Service. These documents provide an insight into corporation expenses, current debt and the profits made during the year.
Review the income information for the corporation by looking at the first six lines of the 1120S federal tax form filed by the corporation. This information, including the cost of goods sold and gross profits, provides the basic information to arrive at the total income or loss for the S corporation. Without examining the additional information presented in the form attachments, however, it's impossible to understand the details of the corporation's profit or loss.
Evaluate the corporate deductions by studying lines 7 through 21 on the federal tax forms. This information summarizes the salaries for leaders of the corporation, total rent paid, advertising expenses and depreciation payments.
Review the information for tax and payments on the first page of form 1120S. Lines 22 through 27 on form 1120S itemize taxes paid to state and federal governments and taxes paid on fuels used by the corporation. The total figure listed at the end of this section shows the amount of taxes paid each year to the federal government.
Examine Schedule B attached to the 1120S tax return. An analysis of this information offers insight into public stock offered by the S corporation and method of accounting used to complete the financial calculations and bookkeeping during the year. Schedule B also offers a listing of the total annual receipts collected by the corporation.
Evaluate the Schedule K 1120S tax return attachment describing the pro rata share items for shareholders of the corporation. This schedule provides key information for analysis of the corporation. The schedule lists summaries of the corporation's business income, any rental expenses, interest income, dividends and royalties. It also itemizes investment income, foreign transactions and any capital gains earned by the corporation.
Study the attached Schedule L "Balance Sheets per Books" for the corporation. The Internal Revenue Service requires the S corporation to file this schedule as part of the tax form 1120S. The form provides valuable financial information about loans taken by the corporation, lists financial obligations, and itemizes corporate investments. The form also lists specific depreciation of the corporation's assets necessary to analyze the S corporation.
Examine schedules M-1, M-2 and M-3 attached to end of form 1120S. These attachments also must accompany form 1120S. These forms provide overall summaries of other required forms, but also provide a total accounting of the travel and entertainment expenses deducted by the corporation on federal taxes.
- While an analysis of federal tax form 1120S for a single year provides an insight into the corporation, reviewing several years of tax forms gives a better overall picture of the long-term health of the S corporation.
- Department of the Treasury Internal Revenue Service: Form 1120S -- U.S. Income Tax Return for an S Corporation
- Cornell University Law School Legal Information Institute: S Corporation Defined
- Cornell University Law School Legal Information Institute: Election; Revocation; Termination
- FindLaw: U.S. Code - Section 1361 -- S Corporation Defined
- Internal Revenue Service: S Corporations
- Internal Revenue Service: Schedules M-1 and M-2 (Form 1120-F)
- Internal Revenue Service: Exempt Organizations Annual Reporting Requirements -- Form 990, Part VI and Schedule L
- Internal Revenue Service: Instructions for Form 8865 -- Main Contents
- Internal Revenue Service: Schedule M-3 (Form 1120S) -- General Instructions
- Department of the Treasury Internal Revenue Service: Schedule K-1 (Form 1120S)
- Internal Revenue Service: Publication 583 -- Starting a Business and Keeping Records
- Department of the Treasury Internal Revenue Service: Publication 542 -- Corporations
- Internal Revenue Service: S Corporation Stock and Debt Basis
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