Corporations and partnerships

• Author: Nicholas L. Bourdeau
• Pages: 181-208

12-1

12-1

Chapter 12

Corporations and Partnerships

TABLE OF CONTENTS

§12:00 THEORY

§12:10 INTERNAL CONTROL

§12:20 INCOME TRANSFER

§12:20.1 C Corporations - Form 1120

§12:20.2 S Corporations - Form 1120S

§12:20.3 Partnerships

§12:30 INCOME CONTROL

§12:30.1 Battle Lines

§12:40 THE INVESTIGATION

FORMS

QUICK TAKE

Corporations and partnerships are legal entities which are normally considered to be

separate and distinct from their owners. The presence of these entities adds at least one addi-

tional layer of inquiry into child support investigations. The key concept for investigators

is to understand how income or losses flow from the various forms involved (1120, 1120S,

1065, and K-1) to the Form 1040. Understanding this flow will allow investigators to design

effective reviews of the related income components.

WHAT YOU SEEK

Form 1120

Form 1120S

Form 1065

Form K-1

RESOURCES

Internal Revenue Service Instructions for Form 1120

Internal Revenue Service Instructions for Form 1120S

Internal Revenue Service Instructions for Form 1065

Internal Revenue Service Instructions for Schedule K-1

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§12:00 The Determination of Income for Child Support 12-2§12:00 The Determination of Income for Child Support 12-2

§12:00 THEORY

Corporations and partnerships are legal enti-

ties which are recognized as beings separate from

their owners. They have rights and responsibilities

like sole proprietors and have distinct tax report-

ing requirements. The presence of a corporation

or a partnership and the associated additional tax

reporting requirements changes the associated

child support investigations. Essentially, an addi-

tional layer of investigation is added to the entire

process. This means additional discovery requests

and analysis have to be performed. However,

investigators should realize that there is nothing

unique about the components involved in the

review of a corporation or partnership. Each of the

components that are commonly present has been

addressed in previous chapters:

Wages: The corporation or partnership may

pay its owner(s) wages for services rendered.

These types of payments are discussed in Chapter

2, W-2: Wage and Tax Statements.

Rental Income: The owner(s) of a corporation or

partnership may own the building in which the busi-

ness operates. The business pays the owner(s) rent

for the space occupied. Rental income is addressed in

the chapter entitled Schedule E Rental Income.

Interest: A corporation or partnership may pay

owner(s) interest on funds that have been lent to the

business. Interest income is addressed in the chapter

entitled Schedule B Interest and Dividends.

Operating Income: Corporations and partner-

ships, like sole proprietorships, exist to generate

income for their owner(s). They generate revenue

and incur expenses. They are nearly identical in

form and function to sole proprietorships except

that they can be owned by more than one person.

Consequently, all of the review procedures that

are used for a sole proprietorship can be used for

a corporation or a partnership. The detailed review

procedures for sole proprietorships are discussed in

the chapter entitled Schedule C Self-Employment

Income.

All of the components that normally make up

these reviews are discussed in detail elsewhere.

Therefore, this chapter focuses on how all of the

various components come together.

§12:10 INTERNAL CONTROL

In reviewing a Schedule C for self-employed

individuals, investigators should assume that there

is no internal control over the books and records

of the business. That is, unless otherwise indicated,

investigators should assume that the business owner

is in complete control of the records of the busi-

ness. This means that the business owner can ini-

tially record transactions, or change the recording of

transactions to suit his or her needs. These actions

can be contrary to IRS regulations and generally

accepted accounting principles. However, one of

the key differences in corporations and partnerships

is that they can be owned by more than one indi-

vidual. The presence of multiple owners means that,

presumably, the owners will watch out for their own

best interests. This self protection can mean that the

books and records of the company in question are

stated correctly because the owners will insist that

they are. They will insist to insure that they get their

share of the profits and to avoid incurring problems

with the other owners or taxing authorities. There

are notable exceptions to this concept, but, gener-

ally, the presence of multiple, unrelated owners

increases the odds that the books and records of the

company are stated correctly.

§12:20 INCOME TRANSFER

One of the key concepts in investigating the

income generated from corporations or partner-

ships is to recognize how the earnings of the

entities get to the taxpayer. Each type of entity is

addressed in the following sections. In addition,

there are flow charts at the end of this chapter to

assist investigators in visualizing the process.

§12:20.1 C Corporations - Form 1120

These corporations are sometimes referred to

as “true” corporations. They can be owned by one

person or many. The owner(s) are referred to as

shareholders. Income can be transferred out of the

corporation to a shareholder by a number of differ-

ent means. The corporation can pay a shareholder

a salary for services that the shareholder renders

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