An S corporation is a pass-through entityAn entity, such as an S corporation or partnership, that is not subject to income tax. Instead, the entity's income, deductions, and credits are allocated to the owners for inclusion in their respective income tax calculations. whose activities are divided between ordinary business net income/loss and separately stated items. Separately stated items are not part of ordinary business income/loss because they receive special tax treatment. For example, certain items (eg, capital gains) are taxed at preferential tax rates; others are subject to various limitations (eg, net investment income) when reported on a shareholder's tax return.

Gains and losses on collectibles are part of the capital gains and losses netting process. Therefore, they would be separately stated items on Schedule K-1.

(Choice A ) Mark-to-market incomeMark-to-market refers to the practice of updating recorded contract values to reflect current market prices. In futures markets, at the end of each trading day accounts are credited or debited to reflect market gains or losses. This practice is known as daily settlement. does not receive preferential tax treatment for shareholders. Therefore, it is included in nonseparately stated ordinary business net income.

(Choice B) Unearned revenueA liability account that reports consideration received by an entity before the entity has provided goods or services to the customer. is a liability and is reported on the balance sheet, not on Schedule K-1.

(Choice C) Gain from the sale of Section 1245 propertyTangible or intangible depreciable (or amortizable) personal property that is held for more than one year, used for investment or in a trade or business, and is not real property (eg, land, building). is treated as ordinary income. Therefore, it does not receive differential tax treatment and is included in the determination of ordinary business net income.

Things to remember:
An S corporation allocates to its shareholders both ordinary business net income/loss and separately stated items. Separately stated items (eg, gain or loss on the sale of collectibles) are not part of ordinary business net income/loss. Mark-to-market income and Section 1245 gains/losses are examples of items included in ordinary business income.