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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
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