Subchapter S and COD income: a taxpayer defeat.
The Tax Clinic item "Subchapter S Subchapter S
IRS regulation that gives a corporation with 35 or fewer shareholders the option of being taxed as a partnership to escape corporate income taxes. and COD Income: A Taxpayer Victory," TTA TTA Telecommunications Technology Association (Korea)
TTA Teacher Training Agency (UK)
TTA Triangle Transit Authority (Raleigh/Chapel Hill/Durham, North Carolina, USA) , Sept. 1997, p. 558, reported the following:
For the past several years, the Years, The
the seven decades of Eleanor Pargiter’s life. [Br. Lit.: Benét, 1109]
See : Time IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. has been engaged in a tug-of-war with tax practitioners over whether cancellation of debt (COD) income of an insolvent INSOLVENT. This word has several meanings. It signifies a person whose estate is not sufficient to pay his debts. Civ. Code of Louisiana, art. 1980.. A person is also said to be insolvent, who is under a present inability to answer, in the ordinary course of business, the responsibility or bankrupt S corporation flows through to shareholders, thereby increasing their basis in their S stock. Tax practitioners assert that under Sec. 108(a), COD income is tax exempt and, therefore, flows through to increase shareholder outside basis pursuant to Secs. 1366(a)(1)(A) and 1367(a)(1)(A). Not surprisingly, the Service disagrees. Recently, the Tax Court in Winn, TC Memo 1997-286, has weighed in on the taxpayer side; unfortunately, the taxpayer victory, even if affirmed on appeal, does not completely resolve the matter.
This prior Tax Clinic item concluded as follows:
The Tax Court in Winn rejected the IRS's position that COD income incurred by an S corporation is not a Sec. 1366 item of income and never flows through to shareholders. Although this is an important taxpayer victory, it is tempered by the fact that the Service's reliance on Regs. Sec. 1.61-12(b) was misplaced mis·place
tr.v. mis·placed, mis·plac·ing, mis·plac·es
a. To put into a wrong place: misplace punctuation in a sentence.
b. . Further, the Service abandoned, and thus the Tax Court did not consider, the argument that COD income is "deferred" and not tax-exempt under Secs. 1366 and 1367. It is possible that the IRS will revive its argument that Sec. 108(d)(7)(A) operates as an exception to the general subchapter S passthrough scheme. It is also possible that the Service will concede the issue.
On Feb. 19, 1998, the Tax Court withdrew its opinion in Winn and granted summary judgment for the IRS (Winn, TC Memo 1998-71). The Court's action was based on its decision in Nelson, 110 TC No. 12 (1998), which held that a shareholder of an insolvent S corporation may not increase his basis in the corporation's stock to reflect the corporation's COD income.
The court construed Sec. 108(d)(7)(A) to mandate that insolvency is determined--and COD income is excluded from an S corporation's gross income under Sec. 108(a)--at the corporate level. It further construed Sec. 1366(a)(1)(A), in combination with Sec. 108(d)(7)(A), to preclude excluded COD income from recognition at the shareholder level. Therefore, since an S corporation's excludable COD income does not pass through to the shareholders under Sec. 1366(a)(1)(A), it cannot increase their stock's basis under Sec. 1367(a)(1)(A).
The court also stated:
In light of the relatively sparse legislative history that bears on the issue before us, we must construe construe v. to determine the meaning of the words of a written document, statute or legal decision, based upon rules of legal interpretation as well as normal meanings. 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 Tax-deferred income
Dividends, interest, and unrealized capital gains on investments in an account such as a qualified retirement plan, where income is not subject to taxation until a withdrawal is made. would produce a windfall windfall
An unexpected profit or gain. An investor holding a stock that increases greatly in price because of an unexpected takeover offer receives a windfall. to him.