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Petitioner argues that our holding in Nelson v.
Commissioner, supra does not apply in this instance. Petitioner
points out that for the years at issue in Nelson, section 1.1367-
1(d)(2)of the Income Tax Regs., had not yet become effective.
That regulation, which applies to shareholders' basis, provides
in part:
An adjustment for a nontaxable item is determined for the
taxable year in which the item would have been includible or
deductible under the corporation's method of accounting for
federal income tax purposes if the item had been subject to
federal income taxation.
Petitioner contends that if this regulation had been in
effect for the years at issue in Nelson, we would have been
required to reach a different result. We disagree.
In deciding Nelson, we concluded, based on the legislative
history of section 108, that the rule embodied in the regulation
petitioner cites was already in effect. Nelson v. Commissioner,
supra at 118. Nevertheless, we held that "section 108(d)(7)(A)
explicitly provides that the COD income exclusion operates, for
purposes of the subchapter S regime, on the corporate level."
Nelson v. Commissioner, supra at 121.
Section 1.1367-1(d)(2), Income Tax Regs., does not require
that COD income flow through to S corporation shareholders.
Rather it specifies how tax exempt income, which does flow
through from an S corporation to its shareholders, affects those
shareholders' basis. Since we have held there is no such
flowthrough with respect to COD income, section 1.1367-1(d)(2),
Income Tax Regs., does not come into play.
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