Deducting losses after an S corporation terminates.

• Author: Markwood, Linda

Generally, unused losses caused by lack of basis are not available after the S corporation election terminates. However, a special relief provision allows a shareholder to deduct those losses under certain conditions for one year (or more) during the post-termination transition period (PTTP). Also, the corporation can make nontaxable cash distributions to the extent of the accumulated adjustments account (AAA), limited to the amount of stock basis. The PTTP is:

1. The period beginning on the day after the last day of the corporation's last S corporation tax year and ending on the later of--

   1. One year after the last day, or

   2. The due date, including extensions, of that last year's tax return;

2. The 120-day period beginning on the date of a determination that the corporation's S election had terminated for a previous tax year; and

3. The 120-day period beginning on the date of any determination pursuant to an IRS audit occurring after the termination of the S election, if an S corporation item of income, loss, or deduction is adjusted (Sec. 1377(b)). Per Sec. 1377(b)(2), "determination" means (1) a Tax Court decision or a judgment, decree, or other order by any court that has become final; (2) a closing agreement; or (3) an agreement between the corporation and the IRS that the corporation failed to qualify as an S corporation. While the date that a court decision becomes "final" has not been clarified by the IRS, it presumably is the date after which the decision can no longer be modified or appealed.

   The PTTP applies when the S election terminates, regardless of whether the termination occurs voluntarily because the corporation revokes its S election or involuntarily (e.g., an ineligible shareholder acquires stock in the corporation).

   Measurement of the PTTP is illustrated in the following examples.

   Example 1. Measuring the PTTP by the due date of the tax return: A calendar-year S corporation involuntarily terminates its S election on April 10, 2019. The final S corporation tax return (Form 1120S, U.S. Income Tax Return for an S Corporation) is due on March 15, 2020, but can be extended to Sept. 15. Assuming the corporation extends the due date of the return, the PTTP will begin on April 10, 2019, and end on Sept. 15, 2020 (even if the return is filed prior to Sept. 15).

   Example 2. Measuring the PTTP by the expiration of one year after the S election terminates: A calendar-year S corporation voluntarily terminates its S election on Nov...