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remains on petitioners to prove that respondent’s determination
of income tax deficiencies is incorrect.
II. S Corporations
A. General Rules
An S corporation is a small business corporation that has an
S corporation election in effect for the taxable year pursuant to
section 1362(a). Sec. 1361(a)(1). Sections 1366 through 1368
govern the tax treatment of S corporation shareholders. Section
1366(a)(1) provides that a shareholder shall take into account
his or her pro rata share of the S corporation’s items of income,
loss, deduction, or credit for the 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 the 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
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