When the “Government Accountability Office” reported that 68 percent of S corporation returns had errors, a few people who don’t prepare returns for a living were astonished:

By the way, these S Corporation shareholders are mostly comprised of the “small businessmen” that the right-wing anti-tax crowd constantly claims is overtaxed. Hmmmm. Looks like the bigger issue with this group is noncompliance, not overtaxation. We need to increase enforcement efforts, especially focused on the particular items that have tended to be misreported in S corporation returns.

The reaction from tax pros is more like, “you mean 32% of S corporation returns have no activity?”

Breaking news: this stuff is hard. The tax return for an S corporation of any size starts with thousands of transactions that have to be properly recorded – thousands of opportunities for mistakes. Then you start to apply the tax law. You have to find all of the meals and entertainment expenses, and you have to see which ones fail to qualify. Did the S corporation properly include health insurance on the W-2s (probably not)? What about for the owner’s nephew who has a job at the loading dock? Did every fixed asset get capitalized properly? What about the expenses of acquiring it? Can Section 179 apply? Is it new equipment that qualifies for the bonus depreciation rules? Oh, did they apply the Section 263A inventory capitalization rules properly? Did the Section 199 information get properly recorded for all of the shareholders? Interest? Dividends? Are they qualifying dividends? Are there Capital gains? Section 1231 gains – and what about unrecognized Section 1250 gain? Oh, don’t double them up – that Section 1250 number is part of that 1231 number, not an addition to it!

You get the picture. And if you have a multistate return, your fun is just beginning.

Once you think you have taxable income right, then you have to apply it correctly to the K-1 for the shareholders. Then the shareholders have to apply it correctly to their own tax return, even though the IRS-designed K-1 omits crucial information that the taxpayer or his preparer needs – the shareholder’s basis in the tax return, whether the taxpayer is “at-risk” for basis, and the level of the taxpayers involvement in the business.

If 32% of the returns are reported correctly, it’s shocking all right – it’s amazing that so many are
correct. I’d like to see some law professor, or Congresscritter, try do a tough 1120-S perfectly on a deadline and a budget.

Anybody who has prepared returns for very long has had a “doh!” moment along the way – “holy crap, I’ve been doing that wrong!” It’s not because tax preparers or taxpayers are lazy or evil. It’s just hard.

Joe Kristan is a tax shareholder for Roth & Company, a Des Moines, Iowa CPA firm, where he works with closely-held businesses and their owners. Prior to helping start Roth & Company, he worked for two of what are now the Final Four CPA firms. He writes the Tax Update Blog and is available for seminars, first communions, Bar Mitzvahs, etc. You can see his previous posts for GC here.