S Corporations' charitable contributions of appreciated property and shareholders' adjusted basis in S stock.

• Author: Karlinsky, Stewart S.

Before the Pension Protection Act of 2006, P.L. 109-280 (PPA '06), it was generally understood that an S corporation's charitable contribution of appreciated property reduced each shareholder's adjusted basis in stock by the shareholder's pro-rata share of the charitable deduction, which often was a portion of the contributed property's fair market value (FMV). This potentially could result in a shareholder's recognizing gain on the sale of S stock (due to lower basis) related to the S corporation's charitable contributions. If the shareholder had directly owned and contributed the appreciated property, no indirect gain to the shareholder would have been recognized. Also, the use of FMV was inconsistent with the partnership-partner treatment governed by Rev. Rul. 96-11, which requires that the basis of a partner's partnership interest be reduced by the partner's share of the contributed property's basis.

The PPA '06 corrected this problem for tax years beginning in 2006 and 2007. (It is hoped that an extension of this treatment will be enacted in 2008 as part of an extenders bill.) PPA '06 Section 1203(a) amended Sec. 1367(a)(2) to limit the reduction in a shareholder's basis to the shareholder's pro-rata share of the S corporation's adjusted basis of the contributed property, not the FMV. In addition, under Section 3(b) of the Tax Technical Corrections Act of 2007, P.L. 110-172, the Sec. 1366(d) basis limitation does not apply to the amount of appreciation in property an S corporation contributes to charity.

Importantly, the PPA '06 does not change the general shareholder deductibility rule that the deduction is subject to the Sec. 170 contribution limit and, to the extent of the property's basis, does not change the general shareholder deductibility rule that the deduction is subject to the Sec. 1366(d)(1) basis limitation.

Preparer Actions

S corporations that made charitable gifts of appreciated property in tax years beginning in 2006 or 2007 should supply relevant information to shareholders on Schedules K-1.

Example 1: An S corporation is owned by one shareholder, A, who has an adjusted basis of $1,000 in his S stock. In 2007, the S corporation contributes appreciated property with a basis of $200, an FMV of $500, and a long-term holding period to a Sec. 501 (c)(3) charitable organization. The S corporation will reflect on Form 1120S, Schedule K, Shareholders' Pro Rata Share Items, and A's Schedule K-1 a separately reported $500...