No S corp. basis for excluded DOI income.
DOI income is generally included in a taxpayer's gross income under Sec. 61. However, Sec. 108(a)(1) permits insolvent taxpayers to exclude DOI income, provided the DOI occurs when the taxpayer is insolvent, as defined in Sec. 108(d)(3). Under Sec. 108(b), a taxpayer must reduce tax attributes by the excluded DOI income, generally in the following order: (1) net operating losses (NOLs), (2) general business credits, (3) minimum tax credits, (4) capital loss carryovers, (5) adjusted basis of property, (6) passive activity loss and credit carryovers and (7) foreign tax credit carryovers. The corporation may elect to apply the DOI to the property basis first.
Application at the Corporate Level
Sec. 108(d)(7)(A) provides special rules for S corporations, allowing for the exclusion and the reduction of tax attributes at the corporate level. Nelson argued that the shareholder passthrough rules of Secs. 1366(a) and 1367(a) permitted the corporation's DOI income to be included in his basis as tax-exempt income and that the reduction in tax attributes should occur at the shareholder level. His reasoning was that the suspended losses at the shareholder level are deemed NOLs, and, therefore, would be a tax attribute to be reduced. In addition, Nelson cited Sec. 108(b)(4), which states that the reduction of tax attributes will take place "after the determination of the tax imposed." The taxpayer concluded that Sec. 108(b)(4) implies that the determination of tax is at the shareholder level and, therefore, the exclusion passes through to the shareholder level.
The Tax Court disagreed with this analysis; Sec. 108(d)(7)(A) specifically applies the exclusion and reduction of tax at the corporate level. Because Sec. 108 is the specific statutory section that applies to the exclusion of DOI income, it overrides the general shareholder passthrough rules. In addition, the court referred to the tax treatment of partnerships under Sec. 108(d)(6), which states that excluded DOI income is to be applied at the partner level. Prior to the Deficit Reduction Act of 1984, Sec. 108(d)(6) also applied to the shareholder level of an S corporation. However, in 1984, this provision was modified to apply S corporation DOI exclusions at the corporate level. Apparently, Congress intended separate treatment of excluded DOI income for S corporations and partnerships.
Tax-exempt Income vs. Deferred Income
Nelson argued that DOI income was tax-exempt income to the corporation, and, as such, passed through to the shareholder. However, Sec. 108's legislative history indicates that Congress did not intend for DOI income to be tax-exempt; the intent was to defer payment of tax, not to provide for a permanent exemption. The Committee Reports state that "the provision simply defers income" Congress did not want to deter insolvent businesses from taking opportunities by immediately assessing them, nor did it intend to indefinitely exclude DOI income; therefore, it provided for tax deferral under Sec. 108(b)(2).
Under Sec. 108(b)(2), the DOI income excluded from gross income is applied to reduce a corporation's tax attributes. For example, the corporation may elect to first reduce the property basis for excluded DOI income. In doing this, it would reduce the yearly depreciation deduction, which ultimately increases the income in future years and taxable gains on the future sale of the reduced-basis property. Thus, the excluded income is not tax-exempt, but rather tax-deferred. A taxpayer will increase his stock basis as the deferred income is recognized by the corporation and not when the income is initially excluded.
Sec. 108 determines the tax treatment of DOI income of insolvent corporations. This provision overrides the S corporation passthrough provisions, applying the exclusion only at the corporate level.
FROM MICHAEL L. ROULEAU, CPA, MST, ALBIN, RANDALL & BENNETT, CPAs, LEWISTON, ME
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|Title Annotation:||S corporations tax basis concerning discharge of indebtedness income|
|Author:||Rouleau, Michael L.|
|Publication:||The Tax Adviser|
|Date:||Aug 1, 1999|
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