July 29, 2009

The Honorable Douglas H. Shulman

Commissioner of Internal Revenue

1111 Constitution Avenue, NW, Room 3000

Washington, DC 20224

Re: Proposed Revenue Ruling Regarding the Treatment of Noncapital, Nondeductible Expenses with Respect to an S Corporation Shareholder

Dear Commissioner Shulman:

The AICPA is pleased to submit a proposed revenue ruling that attempts to clarify whether or not a shareholder’s portion of noncapital, nondeductible expenses of an S corporation in excess of the shareholder’s basis in stock and debt should be suspended and carried over to future years in order to reduce basis. The proposed ruling also examines whether a different result occurs when an ordering election for basis adjustments is made by the shareholder.  The proposed revenue ruling was drafted by a Task Force of our S Corporation Taxation Technical Resource Panel (Panel) and approved by both the Panel and our Tax Executive Committee. 

We offer this proposed guidance as we seek clarification under sections 1366(d) and 1367 of the Internal Revenue Code and under reg. section 1.1367-1(f) and (g) of the Income Tax Regulations which indicate that deductions are limited by basis and that basis is decreased for noncapital, nondeductible expenses only in the year of loss before basis is decreased for deductible items of loss or deduction.  An exception to this ordering rule for noncapital, nondeductible items occurring only in the year of loss appears to be when a taxpayer makes an election under reg. section 1.1367-1(g) to modify the ordering of basis reductions.  Our reading of the regulatory election language suggests that Treasury and IRS require a trade-off to obtain the benefits of the election such that if a taxpayer first reduces basis by items of deductible loss, it will be required to reduce basis by nondeductible losses carried over from a previous year.  It appears that if an election under reg. section 1.1367-1(g) is not made, no such carryover of noncapital, nondeductible losses is required. 

While we have presented our suggested clarification in the form of a revenue ruling as we believe this may be the simplest way for the Service to clarify this issue, we see no reason why such guidance could not alternatively be issued as a proposed regulation amending section 1.1367-1(c)(2) and by adding examples to section 1.1367-1(h).

The AICPA is the national professional organization of certified public accountants comprised of approximately 350,000 members.  Our members advise clients on federal, state, and international tax matters and prepare income and other tax returns for millions of Americans.  They provide services to individuals, not-for-profit organizations, small and medium-sized businesses, as well as America’s largest businesses. 

Should you have any questions or wish to discuss this request in more detail, please contact Horacio Sobol, Chair of the S Corporation Taxation Technical Resource Panel (Panel) at  horacio.sobol@us.pwc.com; Sydney Traum, Associate Member of the Panel at sydtraum@attorney-cpa.com; or Marc A. Hyman, AICPA Technical Manager at mhyman@aicpa.org.

Very Truly Yours,

Alan R. Einhorn, Chair

Tax Executive Committee

Download Proposed Nondeductible Loss Ruling Document