I am assuming you are referring to a 1120 S because a form 1120 do not prepare Schedule K or issue K-1 to shareholders. All C-corporations pay tax on the entity level. Assuming you mean 1120 -S, then Schedule K and Schedule K-1 is applicable.
When you prepare the federal S-Corp return, and report the interest income, there are two entries made in the form. First of all, you would report total interest in the first screen. Once this is reported, then a second screen will appear that will report interest from US obligations such as treasury bond interest.
All interest income will be reported as an aggregate total in Box 17 Code A. In a supplemental disclosure form, you will include with the K-1, you should instruct the shareholder that part or all this amount is interest from a treasury obligation. Then instruct them to report this in their state return as a subtraction from income because this is interest that is taxable on a federal level but not taxable to the state.
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