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After reviewing the statutory notices of deficiency and
subsequent computations referred to supra, we find that
respondent has not adjusted Michael's, Jody's, and David's
adjusted bases in their stock in accordance with the applicable
law. For the taxable years in issue, a shareholder's adjusted
basis in the stock of an S corporation is: (1) Increased by the
shareholder's pro rata share of the corporation's income; (2)
decreased by the shareholder's pro rata share of the
corporation's losses and deductions; and (3) decreased by the
amount of the shareholder's section 1368 distributions. Sec.
1367; sec. 1.1367-1(e), Income Tax Regs. Respondent erroneously
flip-flopped steps (2) and (3) by decreasing the adjusted bases
by the amounts of the shareholders' distributions before
decreasing the adjusted bases by the amounts of the shareholders'
pro rata shares of losses and deductions.4
We hold that the amounts of Michael's, Jody's, and David's
recognized losses and gains with respect to their stock in the
corporation must be computed in a manner consistent with the law
in effect during the taxable years in issue, as explained supra.
4 For taxable years beginning after Dec. 31, 1996, the
Small Business Job Protection Act of 1996, Pub. L. 104-188, sec.
1309(a)(1), 110 Stat. 1755, 1783, amended the parenthetical
language in sec. 1366(d)(1)(A) to read "(determined with regard
to paragraphs (1) and (2)(A) of section 1367(a) for the taxable
year)". The effect of this amendment was to change the order of
the basis adjustments to that used by respondent in the statutory
notices of deficiency. See H. Rept. 104-586, at 89 (1996), 1996-
3 C.B. 331, 427. This amendment, however, is not applicable to
the taxable years in issue.
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