St. Charles Investment Co., Burton C. Boothby, Tax Matters Person - Page 6

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               The effect of making an election to be an S corporation is             
          that, generally, an S corporation is not subject to income tax;2            
          instead, the shareholders are taxed on their respective shares of           
          the items constituting the S corporation's taxable income.  Secs.           
          1363, 1366.  Section 1371(b)(1) provides that "No carryforward,             
          and no carryback, arising for a taxable year for which a                    
          corporation is a C corporation may be carried to a taxable year             
          for which such corporation is an S corporation."3  On the basis             
          of this provision, respondent disallowed the deduction of the               
          suspended PAL's.                                                            
               Before proceeding to discuss the specific arguments of the             
          parties, we think it important to recognize the purposes which              
          underlay the enactment of sections 469 and 1371 and the overall             
          context applicable to those sections.  Section 469 was enacted in           
          1986 by section 501(a) of the Tax Reform Act of 1986, Pub. L. 99-           
          514, 100 Stat. 2233, in response to legislative concern that                
          certain categories of taxpayers were engaging in activities which           
          generated losses and using those losses to shelter income from              
          other activities.  See Schaefer v. Commissioner, 105 T.C. 227,              
          230 (1995).  It is essentially a transactional provision, i.e.,             
          it deals with the tax treatment of particular activities.  In               

               2  The exceptions are the taxes imposed on built-in gains              
          under sec. 1374 and on excess net passive income under sec. 1375.           
               3  See infra pp. 20-22 for a discussion of the impact of               
          other provisions of sec. 1371(b).                                           

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