RESPONDENT:Commissioner of Internal Revenue
LOCATION:Milford Central School
DOCKET NO.: 99-1295
DECIDED BY: Rehnquist Court (1986-2005)
LOWER COURT: United States Court of Appeals for the Tenth Circuit
CITATION: 531 US 206 (2001)
ARGUED: Oct 02, 2000
DECIDED: Jan 09, 2001
Darrell D. Hallett – Argued the cause for the petitioners
Kent L. Jones – Department of Justice, argued the cause for the respondent
Facts of the case
In 1991, P. D. W. & A., Inc., an insolvent corporation taxed under Subchapter S, excluded its entire discharge of indebtedness amount from its gross income. David Gitlitz and other shareholders were assessed tax deficiencies because they used the untaxed discharge of indebtedness to increase their basis in S corporation stock and to deduct suspended losses. Ultimately, the Tax Court held that Gitlitz and others could not use an S corporation’s untaxed discharge of indebtedness to increase their basis in corporate stock. In affirming, the Court of Appeals held that the discharge of indebtedness amount first had to be used to reduce certain tax attributes of the S corporation and that only the leftover amount could be used to increase their basis. In so holding, the court assumed that the excluded discharge of indebtedness is an item of income subject to passthrough to shareholders.
Does the Internal Revenue Code permit taxpayers to increase bases in their S corporation stock by the amount of an S corporation’s discharge of indebtedness excluded from gross income? If the Code permits such an increase, does the increase occur before taxpayers are required to reduce the S corporation’s tax attributes?
Media for Gitlitz v. Commissioner of Internal Revenue
Audio Transcription for Opinion Announcement – January 09, 2001 in Gitlitz v. Commissioner of Internal Revenue
William H. Rehnquist:
The opinion of the Court in No. 99-1295, Gitlitz against the Commissioner of Internal Revenue will be announced by Justice Thomas.
This case comes to us on the a writ of certiorari to the United States of Court of Appeals for the Tenth Circuit.
Petitioners are shareholders in an insolvent Subchapter S corporation that excluded discharge of indebtedness from its gross income.
Petitioners pass through this their pro rata shares of the discharge of indebtedness as income to their individual tax returns.
Accordingly, increased their basis in corporate stock and deducted their losses.
The commissioner denied the deductions and the Tax Court affirmed that denial.
The Court of Appeals affirm the Tax Court holding that before petitioners could pass through the discharge of indebtedness income to increase their basis, they had to reduce the S Corporation’s tax attributes by the amount of discharge of indebtedness.
By doing that it would have absorbed all of the losses at the corporate level and there would have been nothing to pass through to the taxpayers.
In an opinion filed with the Clerk today, we reverse.
Section 61(a)(12) of the Internal Revenue Code states that discharge of indebtedness is generally included in gross income.
Section 108 merely permits insolvent S corporations to exclude discharge of indebtedness from gross income, and Section 108(e)(1) specifically presumes that discharge of indebtedness remains an item of income.
Discharge of indebtedness income of an insolvent S corporation is therefore subject to pass through as an item of income to shareholders.
Section 108(b)(4)(A) directs that tax attribute deductions shall be made after the determination of the tax imposed for the taxable year of the discharge.
To compute the tax imposed the shareholders must pass through the S corporation’s items of income, increase their basis in corporate stock and take deductions.
Therefore the pass through must occur before the S corporation’s tax attributes are reduced.
In that way it is not absorbed at the corporate level and remains available to the taxpayer.
In this case petitioners did pass through the S corporation’s discharge of indebtedness income, increased their basis, and take their deductions without having already reduced the S corporation’s tax attributes.
They therefore were entitled to the claim deductions.
Justice Breyer has filed a dissenting opinion.