Category: Estate & Gift; Estates & Trusts
Subject: Deceased S Corporation Shareholder
Title: NOL & Basis Considerations
IRC Sections: 469(g); 1366(d), 1015(a)
Filename: 1120.html
Date Produced: 2/97

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Background
Taxpayer (TP), an individual, died owning shares of an S corporation (S). The fair market value of TP's S stock at the date of her death was less than her adjusted basis in the shares.

TP did not materially participate in the business of S; accordingly, income or loss from S was passive income or loss with respect to TP. At the time of her death, TP had suspended passive losses from S of $794,000. By operation of IRC Section 469(g), this entire amount of suspended loss was freed up. After offsetting income on the decedent's final return, the unutilized loss became a net operating loss which was carried back against TP's other income in the prior three taxable years. In the end, a total of some $195,000 of loss was ultimately utilized, either in the final return or as an NOL carryback to prior years. The remainder of the loss was not utilized because of insufficient income.

In addition, prior to TP's death she gave some S stock to her children and grandchildren. At the time of those gifts, TP's basis in her stock exceeded its fair market value.

Issue One
Can the unused net operating loss of $599,000 be utilized by TP's estate or its heirs?

Answer One
The net operating loss carryover does not survive TP's death and hence cannot be utilized either by TP's estate or its heirs.

Issue Two
What is the donee's tax basis in the gifted S stock for purposes of Section 1366(d)?

Answer Two
The donee's stock basis for purposes of determining the amount of pass-through loss deductible by the shareholder is the donor's stock basis, not the lower fair market value of the stock at the time of the gift.

Discussion One
In general, losses can be deducted only by the taxpayer incurring the loss. See, e.g., Messenger Corp. v. Smith, 136 F.2d 172, 174 (7th Cir. 1943), rev'g 42 USTC ¶9641 (N.D. Ind. 1942); and Medeiros v. Comr., 77 T.C. 1255 (1981).

More specifically, a net operating loss is personal to the taxpayer who incurred the loss and cannot be transferred, absent express authorization by statute or regulation, to another taxpayer. New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440-41, 4 USTC ¶1292 (1934). Mellott v. U.S., 257 F.2d 798, 58-2 USTC ¶9661 (3d Cir. 1958); Calvin v. U.S., 354 F. Supp. 202, 66-1 USTC ¶Para.9108 (10th Cir. 1966); Sargent v. U.S., 55-1 USTC ¶9424 (S.D. Cal. 1955).

A decedent and a decedent's estate are clearly two separate taxpayers for tax purposes. See Russell Estate v. Comr., 34 BTA 715 (1936). Accordingly, a decedent's estate, being a separate taxpayer from the decedent, cannot use a loss generated by the decedent prior to death.

The issue of whether capital loss and net operating loss carryovers survive to be utilizable by the decedent's estate is addressed directly in Revenue Ruling 74-175, 1974-1 CB 52. The holding of the ruling is identical to the conclusion set forth earlier in this memo, i.e., the NOL and capital loss carryovers die with the decedent. I have attached a copy of this ruling for your convenience.

Discussion Two
You cite IRC Section 1015(a) which provides in pertinent part as follows.

(a), Gifts After December 31, 1920.--
If the property was acquired by gift after December 31, 1920, the basis shall be the same as it would be in the hands of the donor or the last preceding owner by whom it was not acquired by gift, except that if such basis (adjusted for the period before the date of the gift as provided in section 1016) is greater than the fair market value of the property at the time of the gift, then for the purpose of determining loss the basis shall be such fair market value. [Emphasis added.]

In this case, basis of the gifted stock was indeed greater than its fair market value.
IRC Section 1366(d) provides that the loss deductible by an S corporation shareholder is limited to the shareholder's basis in his stock and debt. Is the donee's basis for purposes of IRC Section 1366(d) the donor's basis or the fair market value of the donated stock at the time of the gift.

The question, it seems to me, is the scope of Section 1015. Is the exception for basis in the case of loss effective only with respect to the sale or exchange of gifted property; or, in the alternative, does the exception have broader application?

Judging from context, Section 1015 and its underlying regulations seem to be narrowly focused on loss from disposition. The cases and rulings under Section 1015 (in the context of losses) deal solely with disposition losses. I cannot locate a case or ruling under Section 1366(d) or Section 704(d), the comparable provision in the partnership area, dealing with this issue. The various commentary sources I have available do not even hint that the loss exception rule under Section 1015 should apply in the context of Section 1366(d).

I conclude from all this that we are on fairly safe ground to use the donor's basis as the starting point for Section 1366. Bear in mind, however, that this issue reappears if the stock is subsequently sold.