Reg. § 1.1366-1 Shareholder's share of items of an S corporation.
(a) Determination of shareholder's tax liability
(1) In general An S corporation must report, and a shareholder is required to take into account in the shareholder's return, the shareholder's pro rata share, whether or not distributed, of the S corporation's items of income, loss, deduction, or credit described in , , and of this section. A shareholder's pro rata share is determined in accordance with the provisions of section and the regulations thereunder. The shareholder takes these items into account in determining the shareholder's taxable income and tax liability for the shareholder's taxable year with or within which the taxable year of the corporation ends. If the shareholder dies (or if the shareholder is an estate or trust and the estate or trust terminates) before the end of the taxable year of the corporation, the shareholder's pro rata share of these items is taken into account on the shareholder's final return. For the limitation on allowance of a shareholder's pro rata share of S corporation losses or deductions, see section and .
(2) Separately stated items of income, loss, deduction, or credit Each shareholder must take into account separately the shareholder's pro rata share of any item of income (including tax-exempt income), loss, deduction, or credit of the S corporation that if separately taken into account by any shareholder could affect the shareholder's tax liability for that taxable year differently than if the shareholder did not take the item into account separately. The separately stated items of the S corporation include, but are not limited to, the following items—
(i) The corporation's combined net amount of gains and losses from sales or exchanges of capital assets grouped by applicable holding periods, by applicable rate of tax under section , and by any other classification that may be relevant in determining the shareholder's tax liability;
(ii) The corporation's combined net amount of gains and losses from sales or exchanges of property described in section (relating to property used in the trade or business and involuntary conversions), grouped by applicable holding periods, by applicable rate of tax under section , and by any other classification that may be relevant in determining the shareholder's tax liability;
(iii) Charitable contributions, grouped by the percentage limitations of section , paid by the corporation within the taxable year of the corporation;
(iv) The taxes described in section that have been paid (or accrued) by the corporation to foreign countries or to possessions of the United States;
(v) Each of the corporation's separate items involved in the determination of credits against tax allowable under part IV of subchapter A (section and following) of the Internal Revenue Code, except for any credit allowed under section (relating to certain uses of gasoline and special fuels);
(vi) Each of the corporation's separate items of gains and losses from wagering transactions (section ); soil and water conservation expenditures (section ); deduction under an election to expense certain depreciable business expenses (section ); medical, dental, etc., expenses (section ); the additional itemized deductions for individuals provided in part VII of subchapter B (section and following) of the Internal Revenue Code; and any other itemized deductions for which the limitations on itemized deductions under sections or applies;
(vii) Any of the corporation's items of portfolio income or loss, and expenses related thereto, as defined in the regulations under section ;
(viii) The corporation's tax-exempt income. For purposes of subchapter S, tax-exempt income is income that is permanently excludible from gross income in all circumstances in which the applicable provision of the Internal Revenue Code applies. For example, income that is excludible from gross income under section (certain death benefits) or section (interest on state and local bonds) is tax-exempt income, while income that is excludible from gross income under section (income from discharge of indebtedness) or section (improvements by lessee on lessor's property) is not tax-exempt income;
(ix) The corporation's adjustments described in sections and , and items of tax preference described in section ; and
(x) Any item identified in guidance (including forms and instructions) issued by the Commissioner as an item required to be separately stated under this .
(3) Nonseparately computed income or loss Each shareholder must take into account separately the shareholder's pro rata share of the nonseparately computed income or loss of the S corporation. For this purpose, nonseparately computed income or loss means the corporation's gross income less the deductions allowed to the corporation under chapter 1 of the Internal Revenue Code, determined by excluding any item requiring separate computation under of this section.
(4) Separate activities requirement An S corporation must report, and each shareholder must take into account in the shareholder's return, the shareholder's pro rata share of an S corporation's items of income, loss, deduction, or credit described in and of this section for each of the corporation's activities as defined in section and the regulations thereunder.
(5) Aggregation of deductions or exclusions for purposes of limitations
(i) In general A shareholder aggregates the shareholder's separate deductions or exclusions with the shareholder's pro rata share of the S corporation's separately stated deductions or exclusions in determining the amount of any deduction or exclusion allowable to the shareholder under subtitle A of the Internal Revenue Code as to which a limitation is imposed.
(ii) Example The provisions of of this section are illustrated by the following example:
Example. In 1999, Corporation M, a calendar year S corporation, purchases and places in service section property costing $10,000. Corporation M elects to expense the entire cost of the property. Shareholder A owns 50 percent of the stock of Corporation M. Shareholder A's pro rata share of this item after Corporation M applies the section limitations is $5,000. Because the aggregate amount of Shareholder A's pro rata share and separately acquired section expense may not exceed $19,000 (the aggregate maximum cost that may be taken into account under section for the applicable taxable year), Shareholder A may elect to expense up to $14,000 of separately acquired section property that is purchased and placed in service in 1999, subject to the limitations of section .
(b) Character of items constituting pro rata share
(1) In general Except as provided in or of this section, the character of any item of income, loss, deduction, or credit described in section or (B) and of this section is determined for the S corporation and retains that character in the hands of the shareholder. For example, if an S corporation has capital gain on the sale or exchange of a capital asset, a shareholder's pro rata share of that gain will also be characterized as a capital gain regardless of whether the shareholder is otherwise a dealer in that type of property. Similarly, if an S corporation engages in an activity that is not for profit (as defined in section ), a shareholder's pro rata share of the S corporation's deductions will be characterized as not for profit. Also, if an S corporation makes a charitable contribution to an organization qualifying under section , a shareholder's pro rata share of the S corporation's charitable contribution will be characterized as made to an organization qualifying under section .
(2) Exception for contribution of noncapital gain property If an S corporation is formed or availed of by any shareholder or group of shareholders for a principal purpose of selling or exchanging contributed property that in the hands of the shareholder or shareholders would not have produced capital gain if sold or exchanged by the shareholder or shareholders, then the gain on the sale or exchange of the property recognized by the corporation is not treated as a capital gain.
(3) Exception for contribution of capital loss property If an S corporation is formed or availed of by any shareholder or group of shareholders for a principal purpose of selling or exchanging contributed property that in the hands of the shareholder or shareholders would have produced capital loss if sold or exchanged by the shareholder or shareholders, then the loss on the sale or exchange of the property recognized by the corporation is treated as a capital loss to the extent that, immediately before the contribution, the adjusted basis of the property in the hands of the shareholder or shareholders exceeded the fair market value of the property.
(c) Gross income of a shareholder
(1) In general Where it is necessary to determine the amount or character of the gross income of a shareholder, the shareholder's gross income includes the shareholder's pro rata share of the gross income of the S corporation. The shareholder's pro rata share of the gross income of the S corporation is the amount of gross income of the corporation used in deriving the shareholder's pro rata share of S corporation taxable income or loss (including items described in section or (B) and of this section). For example, a shareholder is required to include the shareholder's pro rata share of S corporation gross income in computing the shareholder's gross income for the purposes of determining the necessity of filing a return (section ) and the shareholder's gross income derived from farming (sections and ).
(2) Gross income for substantial omission of items
(i) In general For purposes of determining the applicability of the 6-year period of limitation on assessment and collection provided in section (relating to omission of more than 25 percent of gross income), a shareholder's gross income includes the shareholder's pro rata share of S corporation gross income (as described in section ). In this respect, the amount of S corporation gross income used in deriving the shareholder's pro rata share of any item of S corporation income, loss, deduction, or credit (as included or disclosed in the shareholder's return) is considered as an amount of gross income stated in the shareholder's return for purposes of section .
(ii) Example The following example illustrates the provisions of of this section:
Example. Shareholder A, an individual, owns 25 percent of the stock of Corporation N, an S corporation that has $10,000 gross income and $2,000 taxable income. A reports only $300 as A's pro rata share of N's taxable income. A should have reported $500 as A's pro rata share of taxable income, derived from A's pro rata share, $2,500, of N's gross income. Because A's return included only $300 without a disclosure meeting the requirements of section describing the difference of $200, A is regarded as having reported on the return only $1,500 ($300/$500 of $2,500) as gross income from N.
(d) Shareholders holding stock subject to community property laws If a shareholder holds S corporation stock that is community property, then the shareholder's pro rata share of any item or items listed in , , and of this section with respect to that stock is reported by the husband and wife in accordance with community property rules.
(e) Net operating loss deduction of shareholder of S corporation For purposes of determining a net operating loss deduction under section , a shareholder of an S corporation must take into account the shareholder's pro rata share of items of income, loss, deduction, or credit of the corporation. See section and of this section for rules on determining the character of the items. In determining under section the nonbusiness deductions allowable to a shareholder of an S corporation (arising from both corporation sources and any other sources), the shareholder separately takes into account the shareholder's pro rata share of the deductions of the corporation that are not attributable to a trade or business and combines this amount with the shareholder's nonbusiness deductions from any other sources. The shareholder also separately takes into account the shareholder's pro rata share of the gross income of the corporation not derived from a trade or business and combines this amount with the shareholder's nonbusiness income from all other sources. See section and the regulations thereunder.
(f) Cross-reference For rules relating to the consistent tax treatment of subchapter S items, see section .
[T.D. 8852, 64 FR 71645, Dec. 22, 1999]