Court Opinion

ID: 4473025
Source: CourtListenerOpinion
Date Created: 2020-01-14 19:35:02.904376+00
Date Added: 2024-06-11T14:53:50.096844
License: Public Domain

Beghe, J., concurring: I concur in the ultimate conclusion of the majority opinion and the part of it that Judge Foley agrees with, that a straightforward inquiry under section 108 suffices to produce the conclusion. No extended exegesis to determine the character of cod of an insolvent S corporation as “tax-exempt income”, as “deferred income”, or as an unrealized “tax nothing” is needed. Applying the maxim that “superfluity does not vitiate”,1 I therefore concur in more than the “result only” of the majority opinion, even though I don’t join it because I don’t adopt everything it says. By a parity of reasoning, I don’t join Judge Foley’s ‘concurring in result only opinion — even though I fully agree with his text — because of his restrictive description of what he’s concurring in. I — i Section 108(a) provides that gross income does not include COD of an insolvent (or bankrupt) taxpayer. Section 108(d)(7)(A) provides that, in the case of an S corporation, subsections (a) and (b) of section 108 “shall be applied at the corporate level.” Section 108 is properly interpreted in a way that prevents a basis step-up in the stock of an S corporation on account of COD excluded from gross income by section 108(a). To interpret section 108 to the contrary would deprive the S corporation corporate level attribute reduction scheme of any consequence. Following the approach to statutory construction that favors the reading of an ambiguous provision so as to avoid an illogical result that is inconsistent with the larger statutory scheme of which the provision is a part, I join the majority and Judge Foley in reading section 108(d)(7)(A) as an exception to the normal S corporation passthrough regime. Section 108(d)(7)(A) traps the excluded cod of an S corporation at the corporate level in a mode similar to the corporate level rules of sections 1374 and 1375 regarding built-in gains and excess net passive income. Petitioner argues that the only function of section 108(d)(7)(A) is to determine the character of COD as excludable or not at the corporate level and that it’s then passed through to the shareholders under the general passthrough regime of subchapter S. As has been observed, see Blanchard, “Debunking a Shibboleth”, 58 Tax Notes 1673 (Mar. 22, 1993) (letter to editor), if petitioner’s passthrough interpretation were correct, then section 1366(b) would come into play. Section 1366(b) provides that the character of any item included under section 1366(a)(1) as a passthrough item is determined “as if such item were realized directly from the source from which realized by the corporation, or incurred in the same manner as incurred by the corporation”. Section 1366(b) refutes petitioner’s passthrough interpretation of section 108(d)(7)(A). There’s no way, actually or Actively, in which the equivalence rule of section 1366(b) could apply to a solvent shareholder of an insolvent S corporation.2  I — I l-H I mush on in an attempt to make sense of the stipulated record and arrive at an understanding of what happens to the current year’s losses of an insolvent S corporation that experiences COD. The case at hand is not the most satisfactory vehicle for this purpose because the stipulation of facts is so terse — the only documents in evidence are the statutory notice, petitioner’s 1991 income tax return, and MAl’s 1991 Form 1120S — as to raise and leave unanswered questions about what actually happened and the significance of what was shown and claimed on the MAI Form 1120S and petitioner’s return.3  Judge Foley’s reference to the “application of section 108(b) and the resulting reduction of tax attributes (i.e., MAl’s net operating loss)” adverts to an issue that the parties didn’t really address. This issue arises from the fact, which might be inferred from the parties’ stipulation “that the COD income of $2,030,568 exceeded losses of MAI by $1,375,790 in 1991”, that, as respondent asked the Court to find as a fact, “MAI had losses of $654,778”. The amount by which MAl’s COD of $2,030,568 exceeded those losses is $1,375,790, the portion of petitioner’s claimed basis in the stock of MAI that respondent disallowed. Petitioner’s reply brief makes the point-in note 2, but doesn’t return to it in the text, that, under petitioner’s theory of the case, petitioner in the first instance was entitled to increase the basis of his MAI stock by the full amount of MAl’s COD, $2,030,568, unreduced by its $654,778 of losses.4 Petitioner’s argument on the point runs as follows: “Section 108(b)(4)(A) states clearly that the ‘reductions described in paragraph (2) [the attribute reductions] shall be made after the determination of the tax imposed by this chapter for the taxable year of the discharge’. * * * However, under the timing rules of section 108(b)(4)(A), Petitioner should have calculated his tax liability without reducing the COD income by his share of MAl’s loss. * * * [This is because] § 108(b)(4)(A) states that attribute reduction occurs only after the liability for the taxable year of the discharge has been determined.” Thus, taking petitioner’s argument to its next step, petitioner would have sufficient basis in his S corporation stock at the end of 1991 to allow a passthrough of the $654,778 loss and to start 1992 with a net increase of that basis of $1,375,790. That such is the result that seems to follow from petitioner’s argument about the application of the ordering rules of section 108(b)(4), reinforces the correctness of the Court’s conclusion about section 108(d)(7), which specifically applies to S corporations and their shareholders. Section 108(d)(7) trumps section 108(b)(4), which is a provision of more general applicability to insolvent taxable entities, such as C corporations and individuals, who experience COD. Nevertheless, the question remains: How would section 108(d)(7)(B) operate if MAI did actually suffer a 1991 NOL in the amount of $654,778? Section 108(d)(7)(B), as in effect for the year in issue, provides: (B) Reduction in carryover of disallowed losses and deductions. — In the case of an S corporation, for purposes of subparagraph (A) of subsection (b)(2), any loss or deduction which is disallowed for the taxable year of the discharge under section 1366(d)(1) shall be treated as a net operating loss for such taxable year. Ordinarily, the current year’s NOL of an S corporation passes through to its shareholder(s) under section 1366(a)(1)(A). If such a shareholder should lack sufficient basis in his stock in and debt from the corporation to use his share of the NOL currently, it would be disallowed and suspended under section 1366(d)(1). Section 108(d)(7)(B) says that any loss or deduction of an insolvent S corporation with COD that is so suspended shall be treated as an NOL of the corporation and reduced at the corporate level under section 108(b)(2)(A). The foregoing would explain how petitioner arrived at the upward basis adjustment he claimed in the amount of $1,375,790, reducing the total COD of $2,030,568 by the amount of the corporate loss of $654,788, and thereby accounting for the entire amount of MAi’s COD.5 Although we have rejected petitioner’s arguments for the upward basis adjustment he claimed, he and his return preparer deserve credit for not taking a return position as aggressive as his counsel argues he was entitled to. h-H I — I I — I Respondent’s and petitioners briefs in this case and in Winn v. Commissioner, T.C. Memo. 1998-71, and the voluminous literature have devoted inordinate attention to the question of how excluded COD is to be characterized. As made clear by Judge Foley and amplified in Part I above, that question is of no moment. The only relevant inquiry under section 1366 is not whether COD excluded from gross income of an insolvent S corporation is “tax-exempt income”, but whether it’s a passthrough item at all. Because section 108(d)(7)(A) dictates that it isn’t (as the majority and Judge Foley and I agree), it doesn’t pass through to the shareholder under section 1366(a)(1)(A) and can’t increase the basis of his stock under section 1367(a)(1)(A). If the characterization question is to be addressed, as the majority opinion undertakes to do, I believe there’s a complementary relationship between respondent’s “deferred income” argument and respondent’s other argument that COD excluded under section 108 is an unrealized “tax nothing” for the purposes of subchapter S: COD of an insolvent S corporation is “deferred income” to the extent the S corporation has tax attributes to adjust; as to any excess, it’s a “tax nothing”. Both the majority opinion (p. 128) and Judge Foley’s concurring opinion paraphrase and quote as having application the legislative history of the Bankruptcy Tax Act of 1980, S. Kept. 96-1035, at 2 (1980), 1980-2 C.B. 620, 621: “Once a taxpayer reduces its tax attributes pursuant to section 108(b)(2) ‘Any further remaining debt discharge amount is disregarded, i.e., does not result in income or have other tax consequences.’” This language of the legislative history evidences an intent to preserve the notion of section 1.61-12(b), Income Tax Regs.: “Income is not realized by a taxpayer * * * as the result of an adjudication in bankruptcy, or by virtue of an agreement among his creditors not consummated under any provision of the Bankruptcy Act, if immediately thereafter the taxpayer’s liabilities exceed the value of his assets”, at least to the extent that there are no more tax attributes to adjust under section 108(b). I therefore join the majority in rejecting petitioner’s argument that COD is one of the “items of income (including tax-exempt income)” mentioned in section 1366(a)(1)(A) that is passed through to the shareholder(s). In so doing, I disagree with petitioner’s corollary conclusion that all items excluded from gross income under sections 101 through 135 of the Code must be treated as the same kind of “tax-exempt income” under section 1366(a)(1)(A).6  There’s a significant difference between COD under section 108, on the one hand, and items such as life insurance proceeds under section 101 and tax-exempt bond interest under section 103, on the other. The reference to “tax-exempt” income in section 1366(a)(1)(A) is clearly intended to include receipts excluded from gross income under such sections as 101 and 103, which represent returns on or arising from investment by or on behalf of the recipient. The reference does not include excluded cod that is attributable to loans to the S corporation by third-party creditors; the entire structure of the subchapter S regime denies basis to shareholders who lack any such investment. See, e.g., Spencer v. Commissioner, 110 T.C. 62, 79 (1998), and cases cited thereat. IV. In Winn v. Commissioner, supra, the introduction of respondent’s memorandum of facts and law in support of respondent’s objection to petitioner’s cross-motion for partial summary judgment in docket No. 5359-96 observes in passing that, even if the taxpayer should be entitled to the upward basis adjustment he claims, his right to take it into account for current tax purposes would be subject to the at-risk limitations under section 465. I agree with respondent’s observation. Although “section 465 had its origins in Congress’ concern over the use of non-recourse financing or other devices in tax-oriented investments, the scope of section 465 is not limited to tax shelters.” Lansburgh v. Commissioner, 92 T.C. 448, 451 (1989) (citing Peters v. Commissioner, 77 T.C. 1158, 1165 (1981)). The legislative intent of section 465 — to forestall current reductions in income tax liability arising from basis step-ups that haven’t been and won’t be paid for — prescribes yet another antidote for the unpaid basis step-ups claimed by petitioners in the case at hand and other pending cases. Halpern, J., agrees with this concurring opinion.   See, e.g., Cal. Civ. Code, sec. 3637 (West 1997).    It’s interesting but irrelevant that petitioner’s Form 1040 for 1991 includes a Form 982 (Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment)) that indicates petitioner was also insolvent and had substantial COD unrelated to MAI that was applied in reduction of his own NOL for the year and carryovers from prior years. MAI didn’t file a Form 982 of its own with its 1991 Form 1120S.    Perhaps the Rule 155 computation to be submitted by the parties will clarify these matters.    No net operating loss as such in the amount of $654,788 appears on the MAI Form 1120S. The capital loss claimed by petitioner on his return on the disposition of MAI stock (for no consideration) was $2,403,996, apparently not reduced on petitioner’s return by any losses shown by MAI. The stipulated record does not disclose the source of the basis of $1,028,206 of petitioner’s stock of MAI that respondent allowed as a long-term capital loss. One would have thought that, if MAI did have losses of $654,788, and that petitioner did have $1,028,206 of basis in his stock, then under the general ordering rule of sec. 108(b)(2)(A) and (D), such losses would have thus been applied to reduce the basis. MAl’s Form 1120S shows on its face that MAI had ordinary income of $522,091 (gross income less deductions) which petitioner reported on his return and a section 1231 loss of $651,626 and net loss from rental real estate of $3,152, which add up to the losses of $654,788. Nevertheless, the sum of the ordinary income shown above and the losses plus other items on Schedule K of the Form 1120S show an overall loss of $155,287. It also appears that petitioner, in addition to showing a basis increase for his MAI stock, also reported positive income of $2,630,730, which may be attributable in part to the COD of MAI. The manner in which the MAI stock was disposed of is not described in the stipulated record. I would assume that the stock was regarded as worthless. The MAI Schedule L for the 1991 Form 1120S provides an opening balance sheet but not a closing balance sheet.    Left unanswered is my question supra note 3, asking how petitioner could have had a basis of $1,028,206 in his stock of MAI that respondent did not disallow.    I agree with respondent’s argument that the location of sec. 108 with other Code provisions, such as secs. 101 and 103, in subtit. A, ch. 1, subch. B, pt. III, entitled “Items Specifically Excluded From Gross Income”, does not require that all such sections be treated in identical fashion for the purposes of applying sec. 1366(a)(1)(A). See sec. 7806(b) (no inference, implication, etc., as to legal effects to be drawn from arrangement, classification, location, grouping, descriptive matter, etc.).