rr-08-16.pdf

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Part I

Section 1366.– Pass-through of items to shareholders

26 CFR 1.1366-2: Limitations on deduction of pass-through items of an S corporation
to its shareholders
(Also § 1367; 1.1367-1.)

Rev. Rul. 2008-16

ISSUE
If an S corporation makes a charitable contribution of appreciated property in a
taxable year beginning after December 31, 2005, and before January 1, 2008, what is
the amount of the charitable contribution deduction that a shareholder may claim in
circumstances where § 1366(d) of the Internal Revenue Code (Code) limits the
shareholder’s pro rata share of the S corporation’s losses and deductions for the
taxable year in which the property is contributed?
FACTS
Individual A
is the sole shareholder of S Corporation X. At the beginning of X’s
2007 taxable year, A
has a basis of $50x in the X stock. During 2007, X makes a

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charitable contribution of unencumbered real property, with an adjusted basis of $100x
and a fair market value of $190x, in a transaction that qualifies under § 170(c). The
charitable contribution is not subject to the limitations of § 170(e)(1). In 2007, X
has
§1363 taxable income of $30x and a long-term capital loss of $25x.
LAW
Section 170(a) allows as a deduction any charitable contribution (as defined in
§ 170(c)) the payment of which is made during the taxable year. The deduction
allowable by § 170(a) is subject to the limitations of § 170(b).
Section 1.170A-1(c)(1) of the Income Tax Regulations provides that if a
charitable contribution is made in property other than money, the amount of the
contribution is the fair market value of the property at the time of the contribution
reduced as provided in § 170(e)(1) and § 1.170A-4(a), or § 170(e)(3) and
§ 1.170A-4A(c).
Section 1363(b)(2) provides that the taxable income of an S corporation shall be
computed in the same manner as in the case of an individual, except that the
deductions referred to in § 703(a)(2), including the deduction for charitable contributions
provided in § 170, shall not be allowed to the corporation.
Section 1366(a)(1)(A) provides that, in determining the tax of a shareholder,
there shall be taken into account the shareholder’s pro rata share of the corporation’s
items of income, loss, deduction, or credit the separate treatment of which could affect
the liability for tax of any shareholder. Section 1366(a)(1) provides further that the items

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referred to in § 1366(a)(1)(A) include amounts described in § 702(a)(4). Section
702(a)(4) refers to charitable contributions (as defined in § 170(c)).
Section 1366(a)(1)(B) provides that, in determining the tax of a shareholder,
there shall be taken into account the shareholder’s pro rata share of any nonseparately
computed income or loss.
Section 1366(d)(1) provides that the aggregate amount of losses and deductions
taken into account by a shareholder under § 1366(a) for any taxable year shall not
exceed the sum of (A) the adjusted basis of the shareholder’s stock in the S
corporation, and (B) the shareholder’s adjusted basis of any indebtedness of the S
corporation to the shareholder.
Section 1366(d)(2)(A) generally provides that any loss or deduction which is
disallowed for any taxable year by reason of § 1366(d)(1) shall be treated as incurred by
the corporation in the succeeding taxable year with respect to that shareholder.
Section 1.1366-1(a)(2)(i) and (iii) provides that each S corporation shareholder
must take into account separately the shareholder’s pro rata share of the S
corporation’s gains and losses from sales or exchanges of capital assets and the
corporation’s charitable contributions.
Section 1.1366-1(a)(3) provides that each shareholder must take into account
separately the shareholder’s pro rata share of the nonseparately computed income or
loss of the S corporation.

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Section 1.1366-1(b)(1) provides, in part, that the character of any item of income,
loss, deduction, or credit described in § 1366(a)(1)(A) or (B) is determined for the S
corporation and retains that character in the hands of the shareholder.
Section 1.1366-2(a)(4) generally provides that if a shareholder’s pro rata share of
the aggregate amount of losses and deductions exceeds the sum of the adjusted basis
of the shareholder’s stock in the corporation and the adjusted basis of any indebtedness
of the corporation to the shareholder, then the limitation on losses and deductions under
§ 1366(d)(1) must be allocated among the shareholder’s pro rata share of each loss or
deduction. The amount of the limitation allocated to any loss or deduction is an amount
that bears the same ratio to the amount of the limitation as the loss or deduction bears
to the total of the losses and deductions.
Section 1367(a)(1)(B) provides that the basis of each shareholder’s stock in an S
corporation is increased for any period by any nonseparately computed income
determined under § 1366(a)(1)(B).
Section 1367(a)(2)(B) provides that the basis of each shareholder’s stock in an S
corporation is decreased for any period (but not below zero) by the items of loss and
deduction described in § 1366(a)(1)(A).
Section 1.1367-1(f) provides that increases in an S corporation shareholder’s
stock basis that are attributable to income items described in § 1367(a)(1)(B) are made
before decreases in such basis that are attributable to items of loss or deduction
described in § 1367(a)(2)(B).

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Section 1203(a) of the Pension Protection Act of 2006 (Pension Act), P.L. 109-
280, 120 Stat. 780 (2006), amended Code § 1367(a)(2) to provide that the decrease in
shareholder basis under § 1367(a)(2)(B) by reason of a charitable contribution (as
defined in § 170(c)) of property shall be the amount equal to the shareholder’s pro rata
share of the adjusted basis of such property. The Technical Explanation of the Pension
Act, Technical Explanation of H.R. 4, “The Pension Protection Act of 2006,” JCX-38-06
page 271, provides the following illustration of § 1203:
Thus, for example, assume an S corporation with one individual
shareholder makes a charitable contribution of stock with a basis of $200
and a fair market value of $500. The shareholder will be treated as having
made a $500 charitable contribution (or a lesser amount if the special
rules of section 170(e) apply), and will reduce the basis of the S
corporation stock by $200. (Footnote
306: This example assumes that
basis of the S corporation stock (before reduction) is at least $200.)
Section 3(b) of the Tax Technical Corrections Act of 2007 (Technical Corrections
Act), P.L. 172, 121 Stat. 2473 (2007), added § 1366(d)(4), which concerns the
application of the basis limitation rule of § 1366(d)(1) to charitable contributions of
appreciated property by S corporations. Generally, under § 1366(d)(1), the amount of
losses and deductions which a shareholder of an S corporation may take into account in
any taxable year is limited to the shareholder’s adjusted basis in his stock and
indebtedness of the corporation. Section 1366(d)(4) provides that, in the case of a
charitable contribution of property, § 1366(d)(1) shall not apply to the extent of the

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excess (if any) of (A) the shareholder’s pro rata share of such contribution, over (B) the
shareholder’s pro rata share of the adjusted basis of such property. Thus, the basis
limitation rule of § 1366(d)(1) does not apply to the amount of deductible appreciation in
the contributed property. See
Description of the Tax Technical Corrections Act of 2007,
JCX-119-07, pages 2-3.
The Pension Act amendment to § 1367(a)(2) and the Technical Corrections Act
amendment to § 1366(d) apply to charitable contributions made by S corporations in
taxable years beginning after December 31, 2005, and before January 1, 2008.
Charitable contributions made by S corporations in taxable years beginning after
December 31, 2007, barring any statutory change, are subject to the law in existence
prior to these amendments. The IRS and Treasury Department are considering issuing
guidance on the treatment of charitable contributions made by S corporations in taxable
years beginning after December 31, 2007.
ANALYSIS
Under the facts of this revenue ruling, X
makes a charitable contribution of
unencumbered real property with an adjusted basis of $100x and a fair market value of
$190x in a transaction that qualifies under § 170(c). The charitable contribution is
treated as a separately stated item of deduction that passes through to A
and is
deductible in computing A
’s individual tax liability. Section 1.1366-1(a)(2)(iii).
Pursuant to § 1.1367-1(f), A’s $50x basis in the X stock is first increased by $30x
under § 1367(a)(1)(B) to reflect A
’s share of X’s taxable income. A’s basis in the X
stock is then decreased (but not below zero) by A
’s pro rata share of the sum of the

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adjusted basis of the contributed property ($100x) pursuant to the flush language of
§ 1367(a)(2) and by A’s pro rata share of X’s long-term capital loss ($25x) pursuant to
§ 1367(a)(2)(B). However, A
’s pro rata share of the aggregate amount of losses and
deductions ($125x) exceeds A
’s basis in the X stock of $80x. Section 1366(d)(1),
accordingly, will limit the allowable losses and deductions to A for X’s 2007 tax year.
Pursuant to § 1366(d)(4), the basis limitation rule in § 1366(d)(1) does not apply
to a contribution of appreciated property to the extent the shareholder’s pro rata share
of the contribution exceeds the shareholder’s pro rata share of the adjusted basis of the
contributed property. Accordingly, the basis limitation rule of § 1366(d)(1) does not
apply to A’s pro rata share of the amount of deductible appreciation in the contributed
property ($90x).
Under § 1.1366-2(a)(4), when a shareholder has losses or deductions in excess
of the sum of the shareholder’s basis in the stock plus indebtedness of the S
corporation to the shareholder, the limitation on losses must be allocated pro rata to
each item of loss or deduction. In the case of a charitable contribution deduction, the
limitation amount allocable to such deduction is determined by reference to the
shareholder’s pro rata share of the contributed property’s adjusted basis pursuant to
§ 1366(d)(4).
In applying § 1.1366-2(a)(4), the amount of the limitation allocable to a charitable
contribution deduction is an amount that bears the same ratio to the § 1366(d) limitation
as the shareholder’s pro rata share of the contributed property’s adjusted basis bears to
the total of the shareholder’s pro rata share of the corporation’s losses and deductions

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(excluding the charitable contribution deduction attributable to the shareholder’s pro rata
share of the fair market value of the contributed property over the contributed property’s
tax basis). Accordingly, the amount of the limitation allocable to A
’s share of X’s
charitable contribution deduction is determined by multiplying A
’s basis in the X stock
($80x) by a fraction, the numerator of which is $100x (the contributed property’s
adjusted basis) and the denominator of which is $125x (the total of the capital loss and
the contributed property’s adjusted basis). Thus, $64x is allocated to the charitable
contribution deduction. The remaining $16x is allocated to the capital loss.
Accordingly, in 2007, the amount of the charitable contribution deduction that A

may claim is $154x. This amount is comprised of A’s pro rata share of the property’s
appreciation ($90x) plus the amount of the loss limitation allocated to A’s pro rata share
of the contributed property’s adjusted basis ($64x). Under § 1367(a)(2)(B), A
’s basis in
the X stock is reduced to 0 to reflect the $16x reduction in basis attributable to the
capital loss and the $64x reduction in basis attributable to the charitable contribution
deduction. Pursuant to § 1366(d)(2), the disallowed portion of the charitable
contribution deduction ($36x) and the capital loss ($9x) shall be treated as incurred by X

in the succeeding taxable year with respect to A
.
HOLDING
If an S corporation makes a charitable contribution of appreciated property during
a taxable year beginning after December 31, 2005, and before January 1, 2008, the
amount of the charitable contribution deduction the shareholder may claim may not
exceed the sum of (i) the shareholder’s pro rata share of the fair market value of the

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contributed property over the contributed property’s adjusted tax basis, and (ii) the
amount of the § 1366(d) loss limitation amount that is allocable to the contributed
property’s adjusted basis under § 1.1366-2(a)(4). Any disallowed portion of the
charitable contribution retains its character and is treated as incurred by the corporation
in the corporation’s first succeeding taxable year, and subsequent taxable years, with
respect to the shareholder.
DRAFTING INFORMATION
The principal author of this revenue ruling is Cynthia D. Morton of the Office of
Associate Chief Counsel (Passthroughs & Special Industries). For further information
regarding this revenue ruling, contact Cynthia D. Morton at (202) 622-3060 (not a toll-
free call).