Category: Individual
Subject: Losses
Title: Suspended S Corporation Losses, Availability after Sale of Stock
IRC Sections: 1366(d)
Filename: 1209.html
Date Produced: 03/95

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Facts
Individual taxpayer (TP) was the sole shareholder of an S corporation. TP had losses suspended under Section 1366 as a result of inadequate stock basis. In 1993, TP sold 100% of his stock. In 1994, TP loaned money to the S corporation in the capacity as a pure creditor.

Issue
Does the 1994 loan provide a means by which TP can deduct his basis-suspended losses?

Answer
TP's suspended losses are lost forever when he sold his stock in 1993. The subsequent loan to the corporation has no effect.

Discussion
Internal Revenue Code Section 1366(d)(1) provides that the aggregate amount of S corporation losses deductible by a shareholder cannot exceed the shareholder's basis in his S corporation stock and debt. Section 1366(d)(2) provides an indefinite carryover for basis-suspended losses; however, the statutory mechanism used for the carryover provision makes it clear that only a continuing shareholder can enjoy the benefit of the carryover. Notice the language of the provision.

Any loss or deduction which is disallowed for any taxable year by reason of paragraph (1) shall be treated as incurred by the corporation in the succeeding taxable year with respect to that shareholder. [Emphasis supplied.]

In other words, basis-suspended losses are treated as new corporate-level losses as of the beginning of each following tax year and such newly-occurring losses are allocated specifically to the shareholder in question. It seems clear that if a taxpayer is no longer a shareholder in the subsequent taxable year, the S corporation cannot allocate such losses to the now former shareholder.

This result seems entirely consistent with the stated legislative purposes of the basis limitation provisions when enacted in 1958.

The purpose of the limitation on shareholders' losses and deductions is to limit the amount of an S corporation's losses and deductions that may be deducted by a shareholder to the adjusted basis of the shareholder's investment in the corporation.

S Rep No 1983, 85th Cong, 2d Sess 220 (1958).

Also consider the following.

The amount of the corporation's losses and deductions that may be deducted are limited to the actual economic outlay of the shareholder in question.

Perry v Commr, 54 TC 1293 (1970), affd per curiam 8th Cir May 12, 1971; Wheat v US, 353 F Supp 720 (D Tex 1973), 73-1 USTC ¶9221, 31 AFTR2d 73-808.

It seems clear that the loss limitation provisions (and by extension the carryover rules as well) are concerned with limiting loss utilization to the taxpayer's economic investment in the corporation in the capacity as a shareholder. Once a taxpayer ceases to be a shareholder, that economic investment has ended and all consideration of loss carryovers ends as well.