Allocating passthrough items to S corporation shareholders.

• Author: Ellentuck, Albert B.

PASSTHROUGH ITEMS FROM AN S CORPORATION are allocated on a per-share, per-day basis (Sec. 1377(a)(1)). Unlike partnerships, there is no provision for special allocations. Generally, this means that passthrough items for the entire year are allocated equally to each day of the tax year and are in turn allocated equally among the shares of stock outstanding on each day of the tax year.

Example 1: GHI Corp. is an S corporation that reports on a calendar year. The corporation's shares are owned 50% by G and 50% by H. For the four months ending April 30, 2008, the company shows a $60,000 loss, but during the next three months of the year it has $30,000 net income. During the final five months, GHI has $20,000 net income, resulting in a $10,000 net loss for the year. The loss is the only passthrough item for the year. How is the income or loss allocated to the shareholders?

Under the per-share, per-day method, non-separately stated income or loss and separately stated items for the entire tax year are allocated among the shareholders. Here, the net loss for the year ($10,000) is allocated 50% ($5,000) to G and 50% ($5,000) to H. The $10,000 loss is reported on Schedule K of Form 1120S, U.S. Income Tax Return for an S Corporation, and each shareholder's $5,000 portion is passed through on a separate Schedule K-1.

Allocations When Ownership Changes

The allocation is more complex when ownership changes during the year.

Example 2: On May 1, 2008, I begins working for GHI and enters negotiations to buy GHI stock. On July 31, I acquires half of H's shares. All the shareholders actively participate in the business. I asks his tax practitioner if he can report part of the loss on his individual return, even though the loss occurred before he acquired his shares. Can I benefit from the loss incurred before he purchased his shares?

When shares change hands during the year, application of the per-share, per-day method is very cumbersome. The instructions to Form 1120S, however, set out a simplified method. The allocation under this method is made by multiplying the percentage of stock owned by the percentage of the year it is owned and applying the resulting percentage to the corporation's income for the year. Using that method, the passthrough to G, H, and I is as shown in the exhibit on p. 846. Each passthrough item is allocated to the shareholders based on these percentages. Here, the only item is $10,000 of ordinary loss, and it is passed through as...