(Part 9 is continuation of series, links to all parts are provided at end of this blog post. This valuable series on Dividing Property In Divorce Tax Traps has been updated for the Tax Cuts And Jobs Act (TCJA) and the Cares Act. This series is provided by David Ellis of Ellis & Ellis CPAs in Pasadena, CA.)
d.Losses of S Corporations
Both passive and active owners of S Corporations can only deduct losses to the extent that they have basis in the stock of the S Corporation. Generally, taxpayers acquire basis in S Corporation stock by receiving pass throughs of profits, making capital contributions, or making loans directly to the S Corporation.
When the owners of S Corporation stock receive pass through losses that are in excess of their basis, such losses are carried over until the stockholders re-establish enough basis in the stock to deduct the loss in whole or in part.
(1) S Corporation losses follow the stock.
For transfers of S Corporation stock incident to a divorce after 2004, any concomitant losses escheat to the spouse obtaining or keeping the stock.
(2)Carry over losses following the stock are treated as if they were incurred by the S Corporation in the subsequent year.
Example: Ricky and Lucy are divorcing. Ricky owns stock in a calendar year S Corporation, Tropicana Inc., in which he has zero basis and a $10,000 carryover suspended losses. On December 31, 2015 Ricky and Lucy’s divorce is finalized and on that same day Ricky transfers all his shares in Tropicana Inc. to Lucy. For tax purposes, the loss follows the stock ownership, so (subject to the various passive/active loss rules, etc.) Lucy can deduct some or all of the carryover loss when she reacquires basis in the stock.
e.Other Carry Forwards
The tax code is replete with various credits and carry forwards, any of which may become an issue in allocating property pursuant to a divorce. For most of these credits and carry forwards, there is no specific guidance on how they are to be allocated short of requesting an expensive and time consuming Private Letter Ruling from the IRS. Practitioners are left to rely principally on common sense and reasonableness to make the appropriate allocations.
As a general rule, where no published guidance exists, a practitioner would probably be considered to be on reasonable ground, if the carry forward in question were allocated to the property from whence it came. In other words, the carry forward follows the property, as in the case of suspended losses from S. Corporations following the stock. There is in fact a dollop of guidance from the IRS for this approach in the form of a Private Letter Ruling regarding Rehabilitation Tax Credits for a building. In this case, the credits were generated on a couple’s joint return. The couple divorced and one spouse was given the building as part of the property settlement agreement. The question of how to allocate the carryover of the rehabilitation credits from the original joint tax return presented itself, and the issue was laid at the feet of the IRS via a request for a Private Letter Ruling. The IRS ruled that the credit carry forward followed the property, therefore the spouse receiving the property was entitled to the credit, as well as responsible for any potential for recapture. As always, this Private Letter Ruling only applies to the taxpayer for which it was issued, but it at least gives practitioners a window into how IRS views the matter, as well as some basis for applying the same logic to similar credits.
(Next In Series Part 10 Will Discuss Recapture of Depreciation)
All Tax Practitioners And Taxpayers Welcome To Contact David With Questions.
Have a question? Contact David Ellis, Ellis & Ellis CPAs.
(This material is for informational purposes only and is not a substitute for tax advice from a qualified professional and the author assumes no liability whatsoever in connection with its use. No advisor/client relationship exists.)
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