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S corporation’s taxable year ending with or in the shareholder’s
taxable year. Stated otherwise, section 1366 establishes a
regime under which items of an S corporation are generally passed
through to shareholders, rather than being subject to tax at the
corporate level. Section 1366(d)(1), however, limits the
aggregate amount of such flowthrough losses and deductions that a
shareholder may claim to the sum of (1) his or her adjusted basis
in stock of the S corporation and (2) his or her adjusted basis
in any indebtedness of the S corporation to the shareholder.
As regards basis, section 1012 sets forth the foundational
principle that the basis of property for tax purposes shall be
the cost of the property. Cost, in turn, is defined by
regulation as the amount paid for the property in cash or other
property. Sec. 1.1012-1(a), Income Tax Regs. Section 1367 then
specifies adjustments to basis applicable to investments in S
corporations. Basis in S corporation stock is increased by
income passed through to the shareholder under section 1366(a)(1)
and decreased by, inter alia, distributions not includable in the
shareholder’s income pursuant to section 1368; items of loss and
deduction passed through to the shareholder under section
1366(a)(1); and certain nondeductible, noncapital expenses. Sec.
1367(a).
Section 1368 addresses treatment of distributions and
differentiates between S corporations having accumulated earnings
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