Regulations: final Regs. issued on S Corp. DOI income exclusion and tax attributes.

• Author: Nevius, Alistair M.
• Position: Discharge of indebtedness

On October 30, the IRS issued final regulations (T.D. 9469) governing how an S corporation reduces its tax attributes under Sec. 108(b) when the S corporation has discharge of indebtedness (DOI) income that is excluded from gross income under Sec. 108(a).

The regulations address situations in which the aggregate amount of the shareholders' disallowed Sec. 1366(d) losses and deductions that are treated as a net operating loss (NOL) tax attribute of the S corporation exceeds the amount of the S corporation's excluded DOI income. The final regulations generally adopt the provisions of proposed regulations that were issued in August 2008 (REG-102822-08).

Background

Sec. 108(a) excludes DOI income from gross income if the discharge occurs while the taxpayer is bankrupt or insolvent, in which case the exclusion from income is limited to the amount by which the taxpayer is insolvent. Under Sec. 108(b), the taxpayer must reduce certain specified tax attributes--in a specified order--to the extent DOI income is excluded from gross income. The first tax attribute reduced is any NOL and any NOL carryover for the tax year of the discharge.

Under the rules of Sec. 1366(a), if an S corporation excludes DOI income from its gross income under Sec. 108(a), the amount excluded reduces the S corporation's tax attributes under Sec. 108(b). The reduction of tax attributes occurs after the S corporation's items of income, loss, deduction, and credit for the tax year of the discharge pass through to its shareholders under Sec. 1366(a).

Final Regulations

The final regulations provide an ordering approach for determining the character of the amount of the S corporation's excess deemed NOL that is allocated to a shareholder. The approach is based on one commentator's recommendation that the final regulations' approach be consistent with the method for determining the character of a shareholder's losses and deductions under Sec. 1366(d). Under this approach, an S corporation's excess deemed NOL that is allocated to a shareholder consists of a proportionate amount of each item of the shareholder's loss or deduction that is disallowed for the tax year of the discharge under Sec. 1366(d)(1).

The final regulations also modify the shareholder information reporting requirement so the S corporation does not have to depend on shareholders who fail to furnish information or who provide incorrect information. In certain situations, the S corporation may rely on its own books...