Court Opinion

ID: 4483462
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:16:07.293145+00
Date Added: 2024-06-11T09:56:17.718235
License: Public Domain

Hall, J., dissenting: I respectfully dissent in respect to that portion of the majority’s opinion which holds that petitioner is entitled to deduct only a fraction (267/365) of the operating losses incurred by his two subchapter S corporations during the taxable years ending January 31,1967. I would hold that as a result of the subchapter S elections, sections 1371-1377 preempt the field and allow the petitioner as a shareholder of the two subchapter S corporations ordinary deductions for the full amount of the corporations’ operating losses during their taxable years ended January 31,1967, to the extent of his adjusted basis in the stock and any indebtedness of the corporations to him. The losses from his business are to be treated in the same manner as if the business had been conducted as a sole proprietorship. In this case, very different tax results follow from the order in which two deductions are taken. If the worthless stock (capital) loss must be taken first, basis is reduced to zero and no section 1374 ordinary deduction is available. On the other hand, if a section 1374 deduction is taken first, the basis is thereby used up and little or no worthless stock loss remains. The majority adopts the apparently Solomonic solution of splitting the taxable year, “presuming” contrary to fact, that the stock was “disposed of” when the corporations became bankrupt. I am of the view, however, that the correct “stacking” rule for a subchapter S corporation is to permit the section 1374 deduction for the full taxable year’s losses, and to reduce the stock basis accordingly at the end of the taxable year and to limit a subchapter S corporation’s worthless stock loss to any basis unrecovered after all available section 1374 deductions and section 1016(a)(18) adjustments have been applied. Rather than search for fragmentary purported clues to a “Congressional intent” through overly close sifting of the statutory provisions, I believe we should frankly recognize the fact that Congress failed to advert to the question of the proper stacking order here. Had it considered the matter it would surely have incorporated far more precise directions in the statute, or at least in committee reports. As it is, nothing on the face of the statutory language or in legislative history definitively instructs us which deduction is to be given priority. It seems quite possible within the statutory framework to argue for stacking either deduction below the other, or even to split the difference, as does the majority. Under these circumstances, I believe the soundest result will be achieved by considering which stacking rule best effectuates the general congressional purpose underlying sub-chapter S. So viewed, there can be little doubt that the proper rule is to give the section 1374 deduction preference. Subchapter S was designed to assimilate, insofar as possible, tax attributes of an electing corporation to those of a partnership or proprietorship. Section 1374(a) provides that a subchapter S corporation’s net operating loss “shall be allowed as a deduction from gross income of the shareholders of such corporation.” The amount of the allowable deductions is limited by section 1374(c)(2) to the shareholder’s adjusted basis for the stock and the corporation’s indebtedness to the shareholder. Once the subchapter S election has been made and as long as it remains in effect, these provisions clearly contemplate that the corporation’s operating losses are to be passed through to and deducted by the shareholders. Thus S. Rept. 1983, 85th Cong., 2d Sess. (1958), 1958-3 C.B. 1009, states: Under this provision the net operating losses of the corporation currently also are passed through to the shareholder. Thus, at the corporate level where this special treatment is elected, there is no carryover or carryback of operating losses to or from a year with respect to which this special treatment has been elected. At the individual level these "distributed” corporate losses are to be treated in the same manner as any loss which the individual might have from a proprietorship; that is, they first offset income of the individual in that year (whether or not derived from another business) and then any excess of these losses may be carried back and offset against the individual’s income in prior years and, if any losses still remain, they may be carried forward and offset against his income in subsequent years. [Emphasis added.] House Conference Report 2632, 85th Cong., 2d Sess. (1958), 1958-3 C.B. 1£23, reiterates the intention that the shareholders are to deduct the electing corporation’s losses as if the business were a sole proprietorship as follows: The net operating losses of the small business corporation are passed through currently to the shareholder. There is no carryover or carryback at the corporate level of operating losses to or from a year with respect to which this special treatment has been elected. At the individual level these corporate losses are to be treated in the same manner as any loss which the individual might have from a proprietorship. [Emphasis added.] Generally speaking, Congress intended losses to flow through to the owners to the extent of their basis in corporate stock and debt. See Mason v. Commissioner, 68 T.C. 163, 169 (1977). Respondent’s position herein would frustrate that statutory objective. It would “keep the word of promise to our ear and break it to our hope” in a corporation’s year of failure by depriving the investor of his basis before he could use the year’s losses. I would therefore reject stacking rules which reach that unfortunate result either wholly (respondent) or partially (the majority). Indeed, even if we limit ourselves to clues in the statutory language, and without regard to the legistlative purpose of subchapter S, we reach the same result. In the form effective for the years in controversy section 1374(d)(1) provides'that the deduction allowed to the shareholder shall “for purposes of this chapter, be considered as a deduction attributable to a trade or business carried on by the shareholder.” See the corresponding current provision in section 1374(b). True, the amount of the shareholder’s loss is limited to the amount of his adjusted basis for his stock and any indebtedness of the corporation to him. But, significantly, the amount of such adjusted basis under section 1374(c)(2)(A) and (B) is to be computed “as of the close of the taxable year of the corporation.” Section 1376(b) provides for the reduction of the shareholder’s basis in stock and the corporation’s indebtedness to him by the corporation’s net operating loss attributable to such stock which under section 1374 is deductible by the shareholder. There is no provision in the statute for interrupting the subchapter S corporation’s taxable year to determine whether the shareholder’s stock and the corporation’s indebtedness to him are worthless. It is true that section 1374(b) allows a deduction of operating losses to a shareholder who has that status “at any time during a taxable year * * * in which * * * a net operating loss” has been incurred. Section 1374(c) contemplates that the shareholder’s adjusted basis in his stock shall be determined as of the close of the taxable year of the corporation or as of the close of the last day in such taxable year on which the shareholder was a shareholder in the corporation. It is also true that section 165(g)(1) provides that if a security which is a capital asset becomes worthless during a taxable year the loss resulting therefrom shall be treated as a loss from the sale or exchange on the last day of the taxable year of a capital asset. As a minimum, if this provision is applicable, the taxpayer’s loss should be prorated to December 31, 1966, not to the onset of the bankruptcy, but I do not think these general provisions on losses override the more specific provisions of sections 1374 and 1376 relating to the losses of subchapter S corporations. Featherston and Wilbur, JJ., agree with this dissenting opinion. Wiles, J., dissenting: I respectfully dissent as to the first issue. I cannot agree with the majority’s analysis that “the onset of worthlessness constituted a disposition of petitioner’s interest in the two corporations.” Instead, I would follow this Court’s prior discussion in Levy v. Commissioner, 46 T.C. 531 (1966), and referred to in Zinn v. Commissioner, T.C. Memo. 1972-224. The majority’s finding of a disposition of petitioner’s stock under section 1374(c)(2)(A) permits petitioner an ordinary loss in 1967 under section 1374(b) whereas if there had been no such disposition petitioner would have been restricted to capital loss deductions in 1966 under sections 165(g)(1) and 166(d)(1)(B). More specifically, the majority relies upon sections 165(g)(1) and 166(d)(1)(B) and upon the bankruptcy of the subchapter S corporations to support its conclusion that worthlessness constituted a disposition of the stock within the meaning of the second parenthetical in section 1374(c)(2)(A). The majority fails to cite, and I am unable to find, any support for this analysis. I would limit the interpretation of sections 165(g)(1) and 166(d)(1)(B) to their functions: loss characterization devices. The sale or exchange treatment of sections 165(g)(1) and 166(d)(1)(B) are rules of constructive disposition, not of actual disposition. When stock becomes worthless during the taxable year, section 165(g)(1) provides that “the loss resulting therefrom shall * * * be treated as a loss from the sale or exchange” of the stock. (Emphasis added.) Similarly, section 166(d)(1)(B) provides that “where any nonbusiness debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange * * * of a capital asset held for not more than 6 months.” (Emphasis added.) Congress provided the constructive disposition rule of section 165(g)(1), however, only to establish tax parity between a taxpayer who actually sells or exchanges his stock at a loss and one whose stock merely becomes worthless without actual disposition. Absent this rule, the taxpayer holding worthless stock would be entitled to an ordinary loss while the taxpayer actually disposing of his stock would be limited to a capital loss. This constructive disposition device is not confined to sections 165(g)(1) and 166(d)(1)(B). See, e.g., secs. 302(a), 402(a)(2), 631(a), 1231(a), 1232(a)(1), and 1241. Because Congress has accepted the responsibility or selectively using constructive dispositions, we should be hesitant to expand a statute by implying a sale or exchange or extending the constructive disposition rule of a particular statute. See Helvering v. William Flaccus Oak Leather Co., 313 U.S. 247, 251 (1941); Pounds v. United States, 372 F.2d 342, 350-351 (5th Cir. 1967). The majority also relies upon a state of bankruptcy to argue that petitioner lost all the “economic benefits” of his stock and debt ownership. I believe the only relevance of bankruptcy is to establish the worthlessness of petitioner’s stock and debt in 1966. Presumably the parties as well as the majority agree. The majority notes neither party attached any significance to the bankruptcy other than to establish worthlessness. Moreover, the majority relies upon worthlessness, however suffered, and not bankruptcy as the triggering event for a sale or exchange. Since worthlessness and not bankruptcy is the basis of the majority’s analysis, the loss of economic benefits through bankruptcy is irrelevant. In my view, petitioner, in 1966, will have a section 165(g)(1) deduction for worthless securities and a section 166(d)(1)(B) bad debt deduction. This result is in fact required by Boehm v. Commissioner, 326 U.S. 287, 292 (1945), which states that such losses must be taken in the taxable year of worthlessness. Section 1016(a)(1) would require a 1966 downward basis adjustment to petitioner’s stock and debt leaving him with a zero basis in both at December 31,1966. Then, unless petitioner furnished additional loans and/or capital to the two subchapter S corporations between January 1, 1967, and January 31, 1967, he would have no adjusted basis available to offset any corporate losses under section 1374(c)(2) for the corporate year ended January 31, 1967. As such, the entire amount of the corporate loss for that year would be lost as a deduction. Sec. 1.1374-l(b)(4)(i)(6), Income Tax Regs.1  This is precisely the view expressed in dictum by this Court in Levy v. Commissioner, supra at 538, where we stated under nearly identical facts: The petitioners’ principal contention is that section 1376(b) of the Code requires that the net operating loss of the corporation be first allowed to them as a deduction for 1959 and that the bases of their stock and loans be adjusted on account thereof before determining the amount to be allowed as a deduction on account of the worthlessness of the stock and debts. This contention of the petitioners is, we think, clearly contrary to the plain meaning of the statute. Section 1374(c)(2) specifically provides that a shareholder’s portion of the net operating loss of an electing small business corporation for any taxable year shall not exceed the sum of the adjusted bases, determined as of the close of the corporation’s taxable year, of the shareholder’s stock and the indebtedness of the corporation to him. As pointed out above the petitioners have net shown that the stock and indebtedness did not become worthless in the taxable year 1958 with the consequence that the adjusted bases thereof would be zero at February 28,1959. [Emphasis added.] We subsequently referred to Levy in Zinn v. Commissioner, T.C. Memo. 1972-224. See also B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders, par. 6.07, p. 6-26 n. 54 (3d ed. 1971). I see no reason for deviating now from the view expressed in those prior cases. In reaching this result, I believe the basis provisions of sections 1016(a)(1) and 1016(a)(18) are consistent. These provisions are not operative in and of themselves but adjust the asset “cost” to the taxpayer to reflect the consequences of various taxable transactions. Timing is important here. In this case petitioner’s section 1016(a)(1) adjustments occur in 1966, the year the sections 165 and 166 losses are deducted. Any basis adjustments flowing from the January 31, 1967, net operating losses would be made in 1967, the year of deductibility unless there is an actual disposition of the stock in 1966.2 Secs. 1016(a)(18), 1376(b), and 1374(b); sec. 1.1374r-l(b)(2), Income Tax Regs. In my opinion, the constructive disposition rule of sections 165(g)(1) and 166(d)(1)(B) simply is not intended to create actual dispositions for purposes of applying subchapter S rules. The second parenthetical in section 1374(c)(2)(A) comprehends only actual dispositions. Had petitioner actually disposed of his stock before October 26, 1966, section 1374(c)(2) would operate to fix the amount of his corporate loss which would be deductible as an ordinary loss in 1967 under section 1374(b). Since he failed to dispose of his stock prior to bankruptcy, however, he receives only a capital loss in 1966 for his worthless stock and debt which reduces his basis to zero and thus 1374(c)(2) prevents him from deducting any subchapter S losses under section 1374(b). If Congress intended to allow the subchapter S provisions to override the operation of other controlling statutes such as sections 165(g) and 166(d), then they should have so provided. Until that time, I believe the statutes speak for themselves.3  Fay, Quealy, and Goffe, JJ., agree with this dissenting opinion.  This is an important distinction between subch. S corporations and partnerships. In a partnership, a partner could recoup the partnership loss in a later year by furnishing additional capital. Compare sec. 1.1374-l(bX4)(iX¿>), and sec. 1.704-l(dXl), Income Tax Regs.   Hi the stock is disposed of in 1966 within the meaning of sec. 1374(cX2XA), petitioner’s basis adjustments for his 1967 deductible loss would be made in 1966 under sec. 1016(a)(18). Sec. 1.1376-2(a)(3Xi), Income Tax Regs.   Judge Hall dissents from the majority opinion and would allow a sec. 1374(b) deduction in 1967 as if petitioner had held his stock for the full 1966 calendar year. While I agree with her reasoning which rejects the majority’s Oct. 26,1966, constructive stock disposition theory, I respectfully disagree with her conclusion that petitioner is entitled to a full subchapter S loss deduction in 1967. Essentially, her analysis requires petitioner’s stock and debt basis to be “held open” at Dec. 81,1966, so that the sec. 1016(a)(18) subch. S loss adjustments for 1967 could be made prior to the 1966 secs. 165 and 166 adjustments under sec. 1016(aXl). The problem with this analysis, as her opinion frankly recognizes, is that it lacks any support in the statutory or legislative history. Further, it contradicts the Supreme Court’s analysis in Boehm v. Commissioner, 326 U.S. 287, 292 (1945), which requires losses due to worthlessness to be taken only in the year of worthlessness. Under Boehm, it is not possible to “hold open” 1966. The losses must be taken in 1966 which reduce the basis of petitioner’s stock and debt to zero under sec. 1016(aXl).