Lead Opinion
Respondent determined a deficiency of $69,381 in petitioner’s 1991 Federal income tax. After concessions, the principal issue for decision is whether discharge of indebtedness income realized and excluded from gross income under section 108(a)
FINDINGS OF FACT
This case was submitted fully stipulated pursuant to Rule 122. The stipulation of facts is incorporated herein and found accordingly. Petitioner, Mel T. Nelson, resided in Denver, Colorado, at the time he filed the petition herein. Petitioner was the sole shareholder in Metro Auto, Inc. (MAI), an S corporation.
During the 1991 taxable year, MAI disposed of all of its assets. In the same year, MAI realized discharge of indebtedness income, pursuant to section 61(a)(12), in the amount of $2,030,568 as a result of the disposition and a related agreement between MAI and its creditors.
Petitioner increased the basis of his stock in MAI by $1,375,790 in 1991. Subsequently, petitioner disposed of his stock in MAI and, in turn, claimed a long-term capital loss on his 1991 Federal income tax return in the amount of $2,403,996. Respondent denied $1,375,790 of the loss on the premise that petitioner lacked sufficient basis in his MAI stock.
Ultimate Conclusion
We hold that COD income that is excluded from gross income under section 108(a) does not pass through to a shareholder of an S corporation. Therefore, shareholder basis is not increased.
OPINION
In the instant case, the principal controversy is whether petitioner is entitled to increase the basis in his S corporation stock pursuant to section 1366(a)(1) by his pro rata share of COD income. This issue is a question of law. Babin v. Commissioner,
Section 61 requires that certain amounts be included in income. Absent any exclusionary provision, items of income are included in gross income. Sec. 61(a). Section 61(a)(12) includes COD income in gross income. See also United States v. Kirby Lumber Co.,
There is, however, a condition for the exclusion of COD income. Section 108(b)(1) requires the taxpayer to reduce certain tax attributes by the amount of the debt discharged. In particular, section 108(b)(2) enumerates the tax attributes to be reduced and the order in which they are reduced: (1) Net
Section 108(d)(7) prescribes how section 108(a) and (b) are applied to S corporations. Section 108(d)(7) provides in pertinent part:
(A) * * * [Certain provisions] to be * * * applied at corporate LEVEL. — In the case of an S corporation, subsections (a) [and] (b) * * * shall be applied at the corporate level.
(B) Reduction in carryover of disallowed losses and deductions. — In the case of an S corporation, for purposes of subparagraph (A) of subsection (b)(2), any loss or deduction which is disallowed for the taxable year of the discharge under section 1366(d)(1) shall be treated as a net operating loss for such taxable year.
Section 1366(a) provides, generally, that income, losses, deductions, and credits are passed through pro rata to shareholders on their individual income tax returns. Secs. 1363(a), 1366(a). Section 1366(b) provides that the character of each item of income is determined as if it were realized directly from the source from which the corporation realized it, or incurred in the same manner as by the corporation. A shareholder’s gross income includes a pro rata share of the sub-chapter S corporation’s gross income. Sec. 1366(c). The shareholder’s basis, once computed, limits the amount of losses and deductions that may be taken into account by a shareholder for the taxable year. Sec. 1366(d). Any losses and deduction’s that the shareholder is not entitled to deduct currently are carried forward indefinitely (suspended losses). Id.
Section 1367(a)(1) limits the items by which the shareholder may increase his basis in the stock of an S corporation to the following items, inter alia:
(A) the items of income described in subparagraph (A) of section 1366(a)(1), [and]
(B) any nonseparately computed income determined under subparagraph (B) of section 1366(a)(1)* * *
During the 1991 taxable year, there were no regulations addressing the application of either section 1366(a)(1)(A) or section 1367(a)(1)(A). However, the legislative history provides guidance with respect to section 1366:
The following examples illustrate the operation of the bill’s pass through rules.
its * * :}s H* ‡ :}?
d. Tax-exempt interest — Tax-exempt interest will pass through to the shareholders as such and will increase the shareholders’ basis in their sub-chapter S stock. Subsequent distributions by a corporation will not result in taxation of the tax-exempt income.
[S. Rept. 97-640, at 15-16 (1982), 1982-2 C.B. 718 , 725.]
The Subchapter S Revision Act of 1982 (1982 Act), Pub. L. 97-354, 96 Stat. 1669, enacted section 1367(a) and defined “items of income” by reference to section 1366(a)(1)(A), which refers to “items of income (including tax-exempt income) * * * the separate treatment of which could affect the liability for tax of any shareholder”. The Senate Finance Committee report accompanying the 1982 Act, S. Rept. 97-640, supra at 18, 1982-
3. Basis adjustment (sec. 1367)
Under the bill, both taxable' and nontaxable income will serve * * * to increase * * * a subchapter S shareholder’s basis in the stock of the corporation.
Moreover, the legislative history states, generally, that the basis adjustment rules are analogous to those provided for partnerships under section 705 and require that the basis of a shareholder in an S corporation will be adjusted for income and losses for any corporate tax year before the distribution rules apply for that year.
In the instant case, the parties agree that MAI realized COD income in the amount of $2,030,568 in the taxable year 1991. Moreover, the parties concur that MAI was insolvent at the
In essence, petitioner argues that the excluded COD income is described in section 1366(a)(1)(A) because it could affect his income tax liability if it were treated as a pass-through item of income. In particular, petitioner contends that COD income excluded under section 108(a) is “tax-exempt” income under sections 1366(a) and 1367(a). Thus, petitioner argues that after the amounts are passed through, he is entitled to a basis increase with respect to his MAI stock for the excluded COD income. In sum, petitioner argues that the issue turns on whether COD income is an item of income (tax exempt) that passes through to the S corporation shareholders under section 1366(a)(1)(A) as a separately stated item of income. If it is, petitioner contends that it results in a basis increase.
Conversely, respondent argues that the excluded COD income does not pass through to petitioner as the sole shareholder of MAI under section 1366(a)(1)(A). Specifically, respondent states that the literal language of section 108(d)(7)(A) provides that the exclusion will apply at the S corporation level. Thus, respondent contends that petitioner must apply the reduction in tax attributes under section 108(b) on the corporate level. In other words, respondent argues that the COD income never flows through to petitioner. This, in effect, precludes an increase in basis for petitioner as the shareholder of the S corporation.
Therefore, we examine the juxtaposition of the subchapter S provisions and section 108 to determine whether an S corporation shareholder’s basis in stock may be increased by the amount of COD income derived by the insolvent corporation. We agree with respondent.
Here, the express language of the subchapter S regime provides that the determination of a shareholder’s income tax liability requires that the shareholder must take into account his pro rata share of the corporation’s “items of income (including tax-exempt income), loss, deduction, or credit the separate treatment of which could affect the liability for tax
The parties’ dispute herein centers on the language in section 108(d)(7)(A). Specifically, the parties differ on the precise meaning of the phrase, “In the case of an S corporation, * * * [section 108] shall be applied at the corporate level.” Sec. 108(d)(7)(A). Respondent argues that section 108(d)(7)(A) represents an adjustment and/or exception to the principles underlying the subchapter S provisions that items of income realized or recognized at the corporate level are passed through to the shareholders. On the other hand, petitioner contends that section 108(d)(7)(A) stands for the proposition that prior to the determination of an individual shareholder’s income tax liability, the S corporation must be ascertained to be insolvent.
Petitioner, in effect, argues that the result of the interaction between section 108(d)(7)(B) and (b)(2), as governed by section 108(b)(4), is to apply the attribute reduction rules of section 108(b)(2) at the shareholder level. Section 108(b)(4) states that the reduction in tax attributes will be made “after the determination of the tax imposed * * * for the taxable year of the discharge.” (Emphasis added.) Next, petitioner points out that “suspended losses” under section 1366(d)(1)-(3) are deemed to be net operating losses. Sec. 108(d)(7)(B). Stated in a different manner, the “suspended losses” of section 1366(d)(1) constitute a tax attribute to be reduced pursuant to section 108(b)(2). Such “suspended losses” are determined at the shareholder level. Sec. 1366(d)(1). Consequently, petitioner extrapolates that the reduction in tax attributes occurs on the shareholder level. Similarly, petitioner reasons that COD income excluded under section 108(a)(1) passes through to the shareholder, increases his or her stock basis, and thus affects his or her “suspended
Accordingly, in order for petitioner to prevail in this matter, the COD income otherwise excluded from gross income must pass through the corporate form and be apportioned on a pro rata basis among the subchapter S shareholders. We disagree with petitioner’s statutory approach with respect to the COD income exclusion provision because it is simply not plausible. In this instance, section 108(d)(7)(A) explicitly provides that the COD income exclusion operates, for purposes of the subchapter S regime, on the corporate level. Absent any legislative indication to the contrary, we are required to apply the provision as we find it in accordance with its plain meaning. United States v. American Trucking Associations, Inc.,
In that regard, it is well established that a specific statutory provision will override a general provision. Bulova Watch Co. v. United States,
The literal language at issue here provides that the reduction in tax attributes applies at the corporate level. Sec. 108(d)(7)(A). We do not interpret section 108(d)(7)(A) in a narrow manner. Here, we construe the provision to mandate that insolvency is determined — and COD income is excluded from gross income of an S corporation under section 108(a)— at the corporate level.
Having construed the literal language of the statute, we find our construction of the statute confirmed by a proper view of the statute in the overall statutory scheme. King v. St. Vincent’s Hosp.,
Moreover, we note that section 108(d)(6) provides that, in the case of a partnership, the COD income exclusion will be applied at the partner level. Stated in a different manner, COD income realized by the partnership may result in different outcomes depending upon the financial position of each partner; i.e., insolvent or bankrupt. In contrast, the cod income exclusion is determined at the corporate level for purposes of an S corporation. Sec. 108(d)(7)(A).
Section 108(d)(6) permits the inference that Congress intended to decouple the treatment of the COD income exclusion with respect to partnerships and S corporations. Prior to amendment in 1984, section 108(d) provided that, like partnerships, section 108 applied to S corporations at the owner, not the entity, level. The legislative history of the 1984 amendments to section 108(d)(7)(A) states:
In order to treat all shareholders in the same manner, the bill provides that the exclusion of income arising from the discharge of indebtedness and the corresponding reductions in tax attributes (including losses which are not allowed by reason of any shareholder’s basis limitation) are made at the corporate level. [H. Rept. 98-432, at 1019 (1984).]
Consequently, we believe that Congress intended to preclude the separate treatment and/or outcomes for S corporation shareholders as opposed to the approach delineated in section 108(d)(6).
Furthermore, the ordering rules provide that the income tax liability for the taxable year of the COD income is determined prior to the reduction in tax attributes. Sec. 108(b)(4)(A). The parties have not cited, and we do not find, authority addressing the mechanism of section 108(b)(4)(A). Petitioner asserts that the reductions in tax attributes in section 108(b)(2) are made after the determination of the tax imposed for the taxable year of the discharge. In other words, the income tax liability of an S corporation and its shareholders must be determined first, and only after such liability is determined can the attributes (including losses suspended under section 1366(d)) be reduced. On the other hand, respondent evidently contends that the “suspended losses” of section 1366(d)(1) should be reduced at the S corporation level before the income tax liability of the shareholder is determined. Thus, respondent argues that the losses of the S corporation must be eliminated under section 108(b)(2).
We are not persuaded by petitioner’s argument in this regard. Here, there is nothing in the statutory language which compels excluded COD income to be included in the calculations for an S corporation shareholder’s income tax liability. Also, section 108(b)(4)(A) states that the reduction of the tax attributes occurs after the determination of the tax imposed for “the taxable year of the discharge.” Because section 108(b) applies at the corporate level, we believe that the phrase “taxable year of the discharge” refers to the taxable year of the S corporation. Consequently, the S corporation reduces its tax attributes by the amount excluded from gross income pursuant to section 108(a) at the end of the corporation’s taxable year.
Petitioner suggests that section 108(d)(7)(B) indirectly applies the reduction in tax attributes delineated in section 108(b)(2) at the shareholder level. Thus, petitioner argues that section 108(d)(7)(A) similarly permits the passthrough of the excluded COD income. We do not agree. The language denominated in section 108(d)(7)(B) is fairly explicit. It provides, in pertinent part, that the “suspended losses” of section 1366(d) are deemed to be net operating losses.
Consequently, we do not interpret section 108(d)(7)(B) as an explicit recognition by Congress that excluded COD income is included in the computation of a shareholder’s income tax liability and the subsequent calculation of the “suspended losses” of section 1366(d)(1), nor that section 108(d)(7)(A), through a parallel mechanism, requires that COD income derived by an insolvent S corporation pass through to its shareholders. .
In our view, petitioner has focused his analysis too narrowly in construing the subchapter S provisions in the context of the COD income exclusion. In particular, petitioner asserts that COD income is “tax-exempt” income within the meaning of sections 1366(a)(1)(A) and 1367(a)(1)(A). Consequently, petitioner contends that he is required to take account of the excluded COD income at the shareholder level. In that vein, petitioner attempts to correlate the exclusion from gross income pursuant to section 108 with an item of income that is “tax-exempt” pursuant to section 1366(a)(1)(A), e.g., sections 101(a) (insurance proceeds in excess of premiums paid not subject to taxation), 103(a) (State and local bond interest not subject to taxation), 111(a) (no tax imposed on income arising from the recovery of any
There is no definition of “tax-exempt” for purposes of sections 1366 and 1367. The word “exclusion”, however, has been generally defined to mean the act of excluding or the state of being excluded. Webster’s II New Riverside University Dictionary 450 (1984). In turn, “exclude” is defined as to keep out, or to omit from consideration, and disregard. Id. An exclusion that is subject to an offset (the tax attribute reductions) and may be subject to taxation in the future (that is, excluded from gross income for the taxable year) does not signify or indicate an item of income that is necessarily tax exempt on a permanent basis. In contrast, the language in section 103(a) expressly delineates that gross income does not include income derived from interest paid on any State or local bond. See also Cotton States Fertilizer Co. v. Commissioner,
Moreover, the legislative history with respect to section 108 manifests an intention to “insure that the debt discharge amount eventually will result in ordinary income”. S. Rept. 96-1035, at 11 (1980), 1980-
The effect of section 108 is not genuinely to exempt such income from taxation, but rather to defer the payment of the tax by reducing the taxpayer’s annual depreciation deductions or by increasing the size of taxable gains upon ultimate disposition of the reduced-basis property.
In short, section 108 is not designed or intended to be a permanent exemption from tax. We, therefore, reject petitioner’s argument that excluded COD income is “tax-exempt” pursuant to section 1366(a)(1)(A) and, thus, is statutorily required to pass through to the S corporation shareholders.
Next, petitioner cites CSI Hydrostatic Testers, Inc. v. Commissioner,
We find nothing in sections 1.1502-32 and 1.1502-19, Income Tax Regs., which prevents the application of section 312(1) when calculating a subsidiary’s earnings and profits for the purpose of either the investment basis adjustment rules or the requirement that the balance of an excess loss account be included in a parent corporation’s income when its subsidiary becomes insolvent. Consequently, COD income is included in a subsidiary’s earnings and profits for purposes of computing the parent corporation’s balance in its excess loss account in the stock of its subsidiary under section 1.1502-19, Income Tax Regs. [Id. at 411.]
In other words, we concluded that a specific provision in the Internal Revenue Code (section 312(1)) served to increase the earnings and profits of the subsidiary and resulted in a reduction or decrease in the parent corporation’s income tax liability. Here, there is no express support for the proposition that the COD income must pass through to the shareholders of an S corporation. In that regard, section 108(d)(7)(A) is the applicable provision here and, thus, we must apply it as written. CSI Hydrostatic Testers, Inc. v. Commissioner, supra; Wyman-Gordon Co. v. Commissioner,
Accordingly, there is nothing in the foregoing statutory language that requires or even implies that the COD income passes through to the S corporation shareholders. Hence, we do not conclude from a literal application of the relevant statutory provisions that a shareholder in an insolvent S corporation may increase his or her basis in stock with respect to the excluded cod income.
It is appropriate, however, to examine the legislative history for further evidence of the legislative purposes. United
With these general principles in mind, we examine the legislative history and purpose of section 108. Initially, the insolvency exception was a judicially created doctrine. See, e.g., Fifth Ave.-Fourteenth St. Corp. v. Commissioner,
In light of the relatively sparse legislative history that bears on the issue before us, we must construe what we can to form a proper perspective and provide a definitive answer to this anomalous situation. Here, petitioner has not borne an economic cost. On the contrary, it would appear that the economic cost was to others, the creditors of the corporation. Nor has petitioner made an economic outlay. Section 108 allows an insolvent S corporation to receive COD income sheltered from immediate taxation to its shareholders. To permit petitioner to increase basis in the stock of the corporation on account of such tax-deferred income would produce a windfall to him.
The legislative history further illustrates that once a taxpayer reduces its tax attributes pursuant to section 108(b)(2), “Any further remaining debt discharge * * * does not result in income or have other tax consequences.” S. Rept. 96-1035, supra at 2, 1980-
Furthermore, we reject petitioner’s contention that the exclusion for income from the discharge of qualified real property business indebtedness in section 108(a)(1)(D) is, in effect, an ex post facto exception to the general design of section 108 in which COD income with respect to an insolvent S corporation passes through to the individual shareholders. The legislative history with respect to section 108(a)(1)(D) clarifies that the exclusion and basis reduction are both made at the S corporation level. H. Rept. 103-111, at 624-625 (1993), 1993-
Finally, the Supreme Court has repeatedly held that exemptions as well as deductions are a matter of legislative grace, and that a taxpayer seeking either must demonstrate that he comes squarely within the terms of the law conferring the benefit sought.
In this instance, borrowed funds are excluded from income in the first instance because the corporation’s obligation to repay the funds offsets any increase in the corporation’s assets; if the corporation is thereafter released from its obligation to repay, it will enjoy a net increase in assets equal to the forgiven portion of the debt, and the basis for the original exclusion thus evaporates. See Commissioner v. Tufts,
Here, we note that petitioner’s construction of section 108 permits him to increase his basis in stock despite the absorption and/or elimination of the enumerated tax attributes which is the “cost” of excluding cod income from gross income. Petitioner’s statutory approach, in effect, vitiates the general congressional design of subjecting income in the indefinite future to taxation. See S. Rept. 96-1035, supra at
Thus, we decline to adopt petitioner’s construction which, essentially, grants him an unwarranted benefit in addition to the exclusion from gross income for an insolvent S corporation. We believe that our construction is narrowly drawn and consistent with the statutory design and intent. Nelson v. Commissioner, supra at 1154.
Accordingly, we hold that an S corporation shareholder may not increase basis in stock due to excluded COD income.
To reflect the foregoing,
Decision will be entered under Rule 155.
Reviewed by the Court.
Notes
All section references are to the Internal Revenue Code in effect for the year at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated.
Petitioner conceded (1) respondent’s reduction of a long-term capital loss from a Metro Auto-Pico transaction by $10,000, and (2) respondent’s reduction of allowable passive losses from Western United Service Corp., and Arapahoe Service Corp., by $54,275, thereby increasing petitioner’s taxable income by $54,275.
Discharge of indebtedness is also referred to as cancellation of debt income (COD). For purposes of convenience and clarity in this opinion, we refer to the income generated from the discharge of indebtedness pursuant to sec. 61(a)(12) as COD.
This Court addressed facts similar to those found in the instant case when we ruled on cross-motions for summary judgment in Winn v. Commissioner,
Arguably, the statutory design reflects that the shareholders of an S corporation are generally not entitled to include in their basis for the stock of the corporation their share of the corporation’s indebtedness to third parties. Estate of Leavitt v. Commissioner,
The losses incurred by an S corporation are passed through to the shareholders pursuant to sec. 1366(a)(1) and may be claimed by the shareholders to the extent of their adjusted bases in the corporate stock. In the event these losses exceed a shareholder’s adjusted basis, the losses are “suspended” and may be carried over indefinitely pursuant to sec. 1366(d).
The Supreme Court, over a century ago, observed:
These cases show the principle upon which is founded the rule that a claim for exemption from taxation must be clearly made out. Taxes being the sole means by which sovereignties can maintain their existence, any claim on the part of any one to be exempt from the full payment of his share of taxes on any portion of his property must on that account be clearly defined and founded upon plain language. There must be no doubt or ambiguity in the language used upon which the claim to the exemption is founded. It has been said that a well-founded doubt is fatal to the claim; no implication will be indulged in for the purpose of construing the language used as giving the claim for exemption where such claim is not founded upon the plain and clearly expressed intention of the taxing power. [Bank of Commerce v. Tennessee,
We also note that in order for a shareholder to increase the basis in his or her stock, or in the S corporation shareholder’s adjusted basis derived and apportioned from the indebtedness owed by the corporation itself, to absorb deductions or losses, the shareholder must make a genuine economic outlay. See Uri v. Commissioner,
Concurrence Opinion
concurring in result only: I agree with the majority’s holding. Section 108(d)(7)(A) explicitly provides that subsections (a), (b), (c), and (g) of section 108 are to be applied at the corporate level. I write separately to emphasize that after the application of section 108(b) and the resulting reduction of tax attributes (i.e., MAl’s net operating loss) there are no “items of income”, tax exempt or otherwise, to which section 1366(a) may apply. The legislative history accompanying the Bankruptcy Tax Act of 1980 states that after a taxpayer reduces its tax attributes, “Any further remaining debt discharge amount is disregarded, i.e., does not result in income or have other tax consequences.” S. Rept. 96-1035, at 2 (1980), 1980-
Concurrence Opinion
concurring: I concur in the ultimate conclusion of the majority opinion and the part of it that Judge Foley agrees with, that a straightforward inquiry under section 108 suffices to produce the conclusion. No extended exegesis to determine the character of cod of an insolvent S corporation as “tax-exempt income”, as “deferred income”, or as an unrealized “tax nothing” is needed.
Applying the maxim that “superfluity does not vitiate”,
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Section 108(a) provides that gross income does not include COD of an insolvent (or bankrupt) taxpayer. Section 108(d)(7)(A) provides that, in the case of an S corporation, subsections (a) and (b) of section 108 “shall be applied at the corporate level.”
Section 108 is properly interpreted in a way that prevents a basis step-up in the stock of an S corporation on account of COD excluded from gross income by section 108(a). To interpret section 108 to the contrary would deprive the S corporation corporate level attribute reduction scheme of any consequence.
Following the approach to statutory construction that favors the reading of an ambiguous provision so as to avoid an illogical result that is inconsistent with the larger statutory scheme of which the provision is a part, I join the majority and Judge Foley in reading section 108(d)(7)(A) as an exception to the normal S corporation passthrough regime. Section 108(d)(7)(A) traps the excluded cod of an S corporation at the corporate level in a mode similar to the corporate level rules of sections 1374 and 1375 regarding built-in gains and excess net passive income.
Petitioner argues that the only function of section 108(d)(7)(A) is to determine the character of COD as excludable or not at the corporate level and that it’s then passed through to the shareholders under the general passthrough regime of subchapter S. As has been observed, see Blanchard, “Debunking a Shibboleth”, 58 Tax Notes 1673 (Mar. 22, 1993) (letter to editor), if petitioner’s passthrough interpretation were correct, then section 1366(b) would come into play. Section 1366(b) provides that the character of any item included under section 1366(a)(1) as a passthrough item is determined “as if such item were realized directly from the source from which realized by the corporation, or incurred in the same manner as incurred by the corporation”. Section 1366(b) refutes petitioner’s passthrough interpretation of section 108(d)(7)(A). There’s no way, actually or Actively, in
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I mush on in an attempt to make sense of the stipulated record and arrive at an understanding of what happens to the current year’s losses of an insolvent S corporation that experiences COD. The case at hand is not the most satisfactory vehicle for this purpose because the stipulation of facts is so terse — the only documents in evidence are the statutory notice, petitioner’s 1991 income tax return, and MAl’s 1991 Form 1120S — as to raise and leave unanswered questions about what actually happened and the significance of what was shown and claimed on the MAI Form 1120S and petitioner’s return.
Judge Foley’s reference to the “application of section 108(b) and the resulting reduction of tax attributes (i.e., MAl’s net operating loss)” adverts to an issue that the parties didn’t really address. This issue arises from the fact, which might be inferred from the parties’ stipulation “that the COD income of $2,030,568 exceeded losses of MAI by $1,375,790 in 1991”, that, as respondent asked the Court to find as a fact, “MAI had losses of $654,778”. The amount by which MAl’s COD of $2,030,568 exceeded those losses is $1,375,790, the portion of petitioner’s claimed basis in the stock of MAI that respondent disallowed.
Petitioner’s reply brief makes the point-in note 2, but doesn’t return to it in the text, that, under petitioner’s theory of the case, petitioner in the first instance was entitled to increase the basis of his MAI stock by the full amount of MAl’s COD, $2,030,568, unreduced by its $654,778 of losses.
That such is the result that seems to follow from petitioner’s argument about the application of the ordering rules of section 108(b)(4), reinforces the correctness of the Court’s conclusion about section 108(d)(7), which specifically applies to S corporations and their shareholders. Section 108(d)(7) trumps section 108(b)(4), which is a provision of more general applicability to insolvent taxable entities, such as C corporations and individuals, who experience COD.
Nevertheless, the question remains: How would section 108(d)(7)(B) operate if MAI did actually suffer a 1991 NOL in the amount of $654,778? Section 108(d)(7)(B), as in effect for the year in issue, provides:
(B) Reduction in carryover of disallowed losses and deductions. — In the case of an S corporation, for purposes of subparagraph (A) of subsection (b)(2), any loss or deduction which is disallowed for the taxable year of the discharge under section 1366(d)(1) shall be treated as a net operating loss for such taxable year.
Ordinarily, the current year’s NOL of an S corporation passes through to its shareholder(s) under section
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Respondent’s and petitioners briefs in this case and in Winn v. Commissioner,
If the characterization question is to be addressed, as the majority opinion undertakes to do, I believe there’s a complementary relationship between respondent’s “deferred income” argument and respondent’s other argument that COD excluded under section 108 is an unrealized “tax nothing” for the purposes of subchapter S: COD of an insolvent S corporation is “deferred income” to the extent the S corporation has tax attributes to adjust; as to any excess, it’s a “tax nothing”.
This language of the legislative history evidences an intent to preserve the notion of section 1.61-12(b), Income Tax Regs.: “Income is not realized by a taxpayer * * * as the result of an adjudication in bankruptcy, or by virtue of an agreement among his creditors not consummated under any provision of the Bankruptcy Act, if immediately thereafter the taxpayer’s liabilities exceed the value of his assets”, at least to the extent that there are no more tax attributes to adjust under section 108(b).
I therefore join the majority in rejecting petitioner’s argument that COD is one of the “items of income (including tax-exempt income)” mentioned in section 1366(a)(1)(A) that is passed through to the shareholder(s). In so doing, I disagree with petitioner’s corollary conclusion that all items excluded from gross income under sections 101 through 135 of the Code must be treated as the same kind of “tax-exempt income” under section 1366(a)(1)(A).
There’s a significant difference between COD under section 108, on the one hand, and items such as life insurance proceeds under section 101 and tax-exempt bond interest under section 103, on the other. The reference to “tax-exempt” income in section 1366(a)(1)(A) is clearly intended to include receipts excluded from gross income under such sections as 101 and 103, which represent returns on or arising from investment by or on behalf of the recipient. The reference does not include excluded cod that is attributable to loans to the S corporation by third-party creditors; the entire structure of the subchapter S regime denies basis to shareholders
IV.
In Winn v. Commissioner, supra, the introduction of respondent’s memorandum of facts and law in support of respondent’s objection to petitioner’s cross-motion for partial summary judgment in docket No. 5359-96 observes in passing that, even if the taxpayer should be entitled to the upward basis adjustment he claims, his right to take it into account for current tax purposes would be subject to the at-risk limitations under section 465.
I agree with respondent’s observation. Although “section 465 had its origins in Congress’ concern over the use of non-recourse financing or other devices in tax-oriented investments, the scope of section 465 is not limited to tax shelters.” Lansburgh v. Commissioner,
See, e.g., Cal. Civ. Code, sec. 3637 (West 1997).
It’s interesting but irrelevant that petitioner’s Form 1040 for 1991 includes a Form 982 (Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment)) that indicates petitioner was also insolvent and had substantial COD unrelated to MAI that was applied in reduction of his own NOL for the year and carryovers from prior years. MAI didn’t file a Form 982 of its own with its 1991 Form 1120S.
Perhaps the Rule 155
No net operating loss as such in the amount of $654,788 appears on the MAI Form 1120S. The capital loss claimed by petitioner on his return on the disposition of MAI stock (for no consideration) was $2,403,996, apparently not reduced on petitioner’s return by any losses shown by MAI. The stipulated record does not disclose the source of the basis of $1,028,206 of petitioner’s stock of MAI that respondent allowed as a long-term capital loss. One would have thought that, if MAI did have losses of $654,788, and that petitioner did have $1,028,206 of basis in his stock, then under the general ordering rule of sec. 108(b)(2)(A) and (D), such losses would have thus been applied to reduce the basis. MAl’s Form 1120S shows on its face that MAI had ordinary income of $522,091 (gross income less deductions) which petitioner reported on his return and a section 1231 loss of $651,626 and net loss from rental real estate of $3,152, which add up to the losses of $654,788. Nevertheless, the sum of the ordinary income shown above and the losses plus other items on Schedule K of the Form 1120S show an overall loss of $155,287. It also appears that petitioner, in addition to showing a basis increase for his MAI stock, also reported positive income of $2,630,730, which may be attributable in part to the COD of MAI.
The manner in which the MAI stock was disposed of is not described in the stipulated record. I would assume that the stock was regarded as worthless. The MAI Schedule L for the 1991 Form 1120S provides an opening balance sheet but not a closing balance sheet.
Left unanswered is my question supra note 3, asking how petitioner could have had a basis of $1,028,206 in his stock of MAI that respondent did not disallow.
I agree with respondent’s argument that the location of sec. 108 with other Code provisions, such as secs. 101 and 103, in subtit. A, ch. 1, subch. B, pt. III, entitled “Items Specifically Excluded From Gross Income”, does not require that all such sections be treated in identical fashion for the purposes of applying sec. 1366(a)(1)(A). See sec. 7806(b) (no inference, implication, etc., as to legal effects to be drawn from arrangement, classification, location, grouping, descriptive matter, etc.).