26 U.S.C. § 1366 — Pass-thru of items to shareholders

(a)(1) When figuring a shareholder’s tax for the shareholder’s taxable year in which the S corporation’s year ends, the shareholder must take into account the shareholder’s pro rata share of the corporation’s (A) separately treated income, tax-exempt income, loss, deduction, or credit that could affect a shareholder’s tax, and (B) income or loss not separately computed. The same applies in the final year of a shareholder who dies or of a trust or estate that ends before the corporation’s year ends. Items under (A) include amounts described in section 702(a)(4) or (6). (2) “Nonseparately computed income or loss” means the corporation’s gross income minus deductions allowed under this chapter, leaving out every item described in paragraph (1)(A). (b) The character of an item passed through under subsection (a)(1) is determined as if the shareholder received it directly from its original source or incurred it in the same way the corporation did. (c) When this title requires the shareholder’s gross income to be determined, it includes the shareholder’s pro rata share of the corporation’s gross income. (d)(1) A shareholder’s total losses and deductions under (a) for a year cannot exceed the total of (A) the adjusted basis of the shareholder’s stock, determined with the specified section 1367 adjustments, and (B) the shareholder’s adjusted basis in the corporation’s debt to the shareholder, without the specified adjustment. (2)(A) Except as in (B), a loss or deduction disallowed because of (1) is treated as incurred by the corporation for that shareholder in the next year. (B) If stock is transferred under section 1041(a), the disallowed loss or deduction for that stock is treated as incurred in the next year for the transferee. (3)(A) A loss or deduction disallowed in the corporation’s last S-corporation year is treated as incurred by the shareholder on the last day of the post-termination transition period. (B) The total under (A) cannot exceed the stock’s adjusted basis at that time, ignoring this paragraph. (C) The stock basis is reduced by the amount allowed. (D) If the basis increase in (B) would have increased the shareholder’s at-risk amount under section 465, similar rules apply to losses disallowed under section 465(a). (4) For a charitable property contribution covered by the second sentence of section 1367(a)(2), the limit in (1) does not apply to the excess of the shareholder’s pro rata contribution over the shareholder’s pro rata adjusted basis in the property. (e) If a family member, as defined in section 704(e)(2), of one or more S-corporation shareholders performs services or provides capital for the corporation without reasonable compensation, the Secretary must adjust the items taken into account by that person and the shareholders as needed to reflect the services or capital’s value. (f)(1) Subsection (a) does not apply to a credit allowed under section 34. (2) If an S corporation pays tax under section 1374 for a year, that tax is treated under (a) as an S-corporation loss for that year. The loss is allocated proportionally among the recognized built-in gains that produced the tax. (3) If an S corporation pays tax under section 1375, each passive-investment-income item is reduced by the tax multiplied by that item divided by total passive investment income for the year.