Academic journal article Journal of Accountancy
Does Bankruptcy Terminate S Corp Status?
A business that elects to be an S corporation continues to be taxed as such until the election is terminated. It can be terminated in any of three ways: (1) The shareholders revoke the election, (2) the corporation no longer satisfies the eligibility requirements or (3) the corporation has too much passive income during the three previous tax years.
Alphonse Mourad was the sole shareholder of V&M Management, an S corporation that owned and operated a 275-unit apartment complex. In 1996 V&M petitioned for reorganization under chapter 11 of the Bankruptcy Code. To administer the reorganization, the bankruptcy court appointed an independent trustee who, in 1997, sold the apartment complex. The sale resulted in a gain of $2.l million, which was reported on V&M's 1997 form 1120S and Mourad's 1997 schedule K-1. Mourad did not file a tax return for 1997, the IRS issued him a notice of deficiency for that year and he, in turn, petitioned the Tax Court for relief.
Mourad argued the gain should have been reported by V&M, not by him, since V&M's filing for bankruptcy had terminated its status as an S corporation. The Tax Court disagreed (see Mourad v. Commissioner, 121 TC no. 1). The Tax Court held that a bankruptcy proceeding conducted under chapter 11 did not end S corporation status. Its finding was similar to that in an earlier case, In re Stadler Associates, Inc, 186 Bankr. 762, in which a bankruptcy court decided a petition under chapter 7 of the bankruptcy laws had not terminated S corporation status. In Stadler the court said that, if it permitted a bankruptcy to end S corporation status, it would be adding a fourth way or S corporation termination not specified in the tax code.
Mourad also argued it was unfair to tax him on the income of the property during the bankruptcy proceeding since he had received no benefit from it during that time. …