[templegoon]

Hello,

Can somebody tell me how interest income and expense should be factored into S Corporations reported ordinary income? I thought it was separately stated in K-1. I had two practice questions from Becker that seem to have a discrepancy:

Tap, a calendar-year S corporation, reported the following items of income and expense in the current year:

Revenue $ 44,000

Operating expenses 20,000

Long-term capital loss 6,000

Charitable contributions 1,000

Interest expense 4,000

What is the amount of Tap’s ordinary income?

a. $19,000

b. $13,000

c. $24,000

d. $20,000

Explanation

Rule: IRC Section 1366 controls the pass-through of S corporation income items to shareholders. In general, items are divided into separately stated items (items that could potentially affect the tax liability of the shareholders) and non-separately stated items. Non-separately stated items are lumped together and constitute the S corporation’s ordinary income. Separately stated items are passed through to the shareholders (in a manner similar to partnerships) and retain their tax attributes to the shareholders.

Choice “d” is correct. Tap’s ordinary income is calculated as follows:

Revenue $ 44,000

Operating expenses (20,000)

Interest expense (4,000)

Ordinary income $ 20,000

The long-term capital loss and the charitable contributions are not included in Tap’s ordinary income. They are separately stated items and thus are passed through to the shareholders and retain their tax attributes.

Choice “b” is incorrect. The $13,000 would include both the long-term capital loss and the charitable contributions.

Choice “a” is incorrect. The $19,000 would include the long-term capital loss but not the charitable contributions.

Choice “c” is incorrect. The $24,000 would not include the interest expense.

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An S corporation had the following income and expenses:

Sales $240,000

Rent expense 25,000

Entertainment expense 5,000

Interest income 1,500

Contributions to qualifying charities 600

Section 179 expense 3,000

Depreciation expense 1,800

What would be reported as ordinary income on the corporation’s income tax return?

a. $213,200

b. $208,600

c. $210,700

d. $206,100

Explanation

Choice “c” is correct. Ordinary income is the net of all taxable and deductible ordinary business revenue and expenses not including separately stated items. Ordinary income is $240,000 sales – $25,000 rent expense – $2,500 entertainment expense – $1,800 depreciation expense = $210,700. Per tax law, only 50 percent of the $5,000 entertainment expense is deductible. The Interest income, charitable contributions, and section 179 expense are separately stated items. They flow through to the shareholder(s) separately on Schedule K-1 and are not part of ordinary income.

Choices “d”, “b”, and “a” are incorrect, based on the above explanation.