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section concerning portfolio income, specifically focused on
situations where a payment of nonpassive interest income is
received by a taxpayer on a loan to an entity and a passive
deduction for the interest payment is passed through to the
taxpayer from the entity. See id. The legislative history
contains a specific example of a taxpayer who receives nonpassive
interest income on loans made to a taxpayer’s pass-through entity
from which passive interest deductions are passed through to the
taxpayer. See id. at II-146, 1986-3 C.B. (Vol. 4) at 146. Such
interest is considered “self-charged” interest and therefore
“[lacks] economic significance”. Id. The example involved a
taxpayer who charges $100 of interest on a loan to an S
corporation (engaged exclusively in passive activities) of which
he is the sole shareholder. Under the general application of the
passive loss rules, the taxpayer might be viewed as incurring
$100 of passive activity expense (interest expense passed through
by the S corporation), and having $100 of interest income, which
cannot be offset by the interest-expense deduction because it is
portfolio in nature. Thus, the taxpayer would have to recognize
$100 of taxable income from the transaction, although the
economic substance of the transaction was a payment of interest
to himself.
Likewise, the Staff of the Joint Committee on Taxation
focused on similar issues that could arise if a partnership makes
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Last modified: May 25, 2011