Academic journal article Journal of Accountancy

S Corporation Stock Basis Adjustments

Academic journal article Journal of Accountancy

S Corporation Stock Basis Adjustments

Article excerpt

S corporation shareholders are generally entitled to increase the basis of their holdings by their share of S corporation income, including tax-exempt income. A question that has been debated for several years is whether shareholders can increase their basis if the tax-exempt income in question is cancellation-of-indebtedness (COD) income.

Mel Nelson was the sole shareholder in an S corporation with significant COD income which was nontaxable because the corporation was insolvent. Nelson increased the basis of his stock by the amount of the COD income. The IRS denied the increase and Nelson appealed.

IRC section 1367 says a shareholder can increase his or her basis in S corporation stock for items of income that are described in section 1366(a) (1)(A) and section 1366(a)(1)(B). The code says a shareholder can take into account his or her ratable share of (a) items of income, including tax-exempt income that would affect any shareholder's tax liability and (b) non-separately computed income or loss. Thus, the question is whether COD income falls into either of these categories.

IRC section 108 says COD income is taxable unless the taxpayer is insolvent or qualifies for some other limited exclusion. Section 108(d)(7) says that, for S corporations, the determination of insolvency and the exclusion of COD income should be made at the corporate level.

Result: For the IRS. …

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