Mel T. Nelson - Page 7

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          or decreased by any adjustment of the item of income in a                   
          redetermination of the shareholder's income tax liability.                  
               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.                                         
                                   * * * * * * *                                      
                    d.  Tax-exempt interest--Tax-exempt interest will pass            
               through to the shareholders as such and will increase the              
               shareholders' basis in their subchapter 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, 1982-2 C.B. at 726,             
          further explains:                                                           
               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.                   







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