Because the Form 1120-S K-1 shows a distribution in box 16, it should be treated like other income on the individual’s tax return. True or false?
The correct answer and explanation is:
Correct Answer: False
Explanation:
A Schedule K-1 (Form 1120-S) is issued to shareholders of an S corporation to report their share of the corporation’s income, deductions, credits, and other tax-related items. Box 16 of the K-1 specifically reports items affecting the shareholder’s basis, including distributions, loans, and repayments.
While distributions are shown in Box 16, they are not automatically treated as taxable income on the individual’s tax return. Instead, their taxability depends on the shareholder’s basis in the S corporation stock:
- Non-taxable Distributions:
If the shareholder has sufficient basis in the S corporation (i.e., the total amount invested and retained earnings), the distribution is not taxed. It simply reduces the shareholder’s basis in the S corporation. - Taxable Distributions:
If the distribution exceeds the shareholder’s basis, the excess amount is treated as a capital gain and is reported on Schedule D (Capital Gains and Losses) of the individual’s Form 1040. - Distributions Are Not “Ordinary Income”:
It is a mistake to treat Box 16 distributions like “other income” (e.g., wages, interest, or dividends) on the individual’s tax return. This misunderstanding can lead to overreporting of income and overpayment of taxes.
Conclusion:
Box 16 on the K-1 is informational and requires the taxpayer to track their basis in the S corporation. Distributions may or may not be taxable and are not automatically reported as regular income. Thus, the statement is false — distributions in Box 16 should not be treated like other income unless the basis rules dictate otherwise.