T.C. Memo. 2000-30
UNITED STATES TAX COURT
ROBERT H. AND MILDRED M. BETTISWORTH, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12447-98. Filed January 21, 2000.
Richard W. Hompesch II, for petitioners.
Stephen P. Baker, for respondent.
MEMORANDUM OPINION
JACOBS, Judge: Respondent determined a $45,715 deficiency in
petitioners’ 1994 Federal income tax. The deficiency primarily
stems from the disallowance of a net operating loss carryover due
to insufficient basis in petitioners’ S corporation stock.
The underlying issue for decision is whether discharge of
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indebtedness income excluded from an S corporation’s gross income
under section 108(a) passes through to the S corporation’s
shareholders and, if it does, increases the basis of the
shareholder’s stock under section 1367. We addressed this issue in
Nelson v. Commissioner, 110 T.C. 114 (1998), affd. 182 F.3d 1152
(10th Cir. 1999), wherein we held that cancellation of debt (COD)
income excluded by section 108(a) does not pass through to a
shareholder of an S corporation as an item of income under section
1366(a)(1)(A) so as to allow a corresponding increase in the basis
of the shareholder’s stock under section 1367(a)(1).1 Petitioners
do not agree with our holding in Nelson and request us to “review
and revise” that holding.
All section references are to the Internal Revenue Code as in
effect for the year in issue. All Rule references are to the Tax
Court Rules of Practice and Procedure.
This case was submitted fully stipulated under Rule 122. The
stipulation of facts and the exhibits submitted therewith are
incorporated herein by this reference.
1
Nelson v. Commissioner, 110 T.C. 114 (1998), affd. 182
F.3d 1152 (10th Cir. 1999), was affirmed for the reasons
explained by the U.S. Court of Appeals for the Tenth Circuit in
Gitlitz v. Commissioner, 182 F.3d 1143 (10th Cir. 1999), affg.
Winn v. Commissioner, T.C. Memo. 1998-71, which was decided on
the same day as Nelson.
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Background
Petitioners, husband and wife, resided in Fairbanks, Alaska,
at the time they filed their petition in this case.
At all relevant times, Robert H. Bettisworth (petitioner) was
a 33.3-percent shareholder in Narwhal, Inc. (Narwhal), an S
corporation. At the end of 1992, petitioner’s basis in his Narwhal
stock was zero; in 1993, his basis increased to $68,125 as a result
of a loan he made to the corporation.
Narwhal was in the business of developing real estate. In
1993, Narwhal was forced to surrender most of its real estate
holdings through foreclosure. As a result, Narwhal realized COD
income of $3,321,471. Because Narwhal was insolvent, the COD
income was treated as nontaxable pursuant to section 108. For
1993, Narwhal had ordinary losses of $2,586,238.
Narwhal issued petitioner a Schedule K-1 for 1993, reflecting
his distributive share of Narwhal’s COD income ($1,107,155) and
ordinary losses ($862,078). Petitioner increased the basis in his
Narwhal stock by the amount of his distributive share of Narwhal’s
COD income, and amended returns were filed in order to take
advantage of previously disallowed net operating losses (NOL’s).2
The NOL’s were first carried back 3 years and then carried
2
Before 1993, petitioners had $275,323 in suspended
losses.
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forward.3 In 1994, petitioners used an NOL carryover of $154,971.4
In the notice of deficiency, respondent determined that the
use of Narwhal’s excluded COD income to increase the basis of
petitioner’s stock was improper and consequently there was
insufficient basis for petitioners to use the NOL carryovers.
Respondent made other adjustments to petitioners’ 1994 return based
on the disallowance of the NOL’s. The parties agree that these
adjustments are computational and turn on our resolution of the NOL
issue.
Discussion
Section 1366(d) provides that the aggregate amount of losses
and deductions taken into account by a shareholder of an S
corporation cannot exceed the sum of: (1) The adjusted basis of
the shareholder’s stock in the S corporation; and (2) the
shareholder’s adjusted basis of any indebtedness of the S
corporation to the shareholder. Petitioners maintain that they are
entitled to increase the basis in their Narwhal stock by their
distributive share of COD income and accordingly should be allowed
to deduct certain NOL’s.
Petitioners make no attempt to distinguish their case from
3
Petitioners carried back a total of $85,654 in
suspended losses to 1990, 1991, and 1992. The remaining $991,995
was then carried forward.
4
Petitioners claimed a $164,197 NOL carryover on their
amended 1994 return. We are unable to account for this
discrepancy.
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Nelson. Rather, they contend that in Nelson we failed adequately
to address the following legal issues: (1) Whether COD income is
an item of income that increases basis; (2) whether COD income
constitutes tax-exempt income which passes through to shareholders;
(3) whether section 108(d)(7)(A) operates as an exception to the
general pass-through scheme of sections 1366 and 1367; and (4)
whether Nelson is inconsistent with our holding in CSI Hydrostatic
Testers, Inc. v. Commissioner, 103 T.C. 398 (1994), affd. per
curiam 62 F.3d 136 (5th Cir. 1995). We disagree with petitioners.
Nelson addressed all of these issues. See Nelson v. Commissioner,
supra at 121-129. Our opinion in Nelson controls the situation
involved herein; consequently, we sustain respondent’s disallowance
of the claimed NOL carryover.5
To reflect the foregoing,
Decision will be entered
for respondent.
5
We are mindful that the U.S. District Court for the
District of Oregon recently held that COD income excluded from
gross income under sec. 108(a) passes through to the shareholders
of an S corporation, allowing them to increase the basis of their
stock under sec. 1367. See Hogue v. United States, ___ F. Supp.
2d ___ (D. Or. Jan. 3, 2000). We believe this decision to be
erroneous.