REVENUE RULE 93-36

1993-1 C.B. 187, 1993-19 I.R.B. 4.

Internal Revenue Service
Revenue Ruling

S/CORPORATION TAXABLE INCOME; BAD DEBTS; PASS-THRU OF ITEMS TO SHAREHOLDERS

Published: May 10, 1993

§ 1363.--Effect of Election on Corporation

(See Also Sections 166, 1366.)

§ corporation taxable income; bad debts; pass-thru of items to shareholders. An § corporation that has a nonbusiness bad debt under § 166 of the Code must separately state the debt as a short-term capital loss under § 166(d).

ISSUE

If an § corporation has a nonbusiness bad debt under § 166 of the Internal Revenue Code, does the § corporation compute its taxable income by deducting the debt as an ordinary loss under § 166(a) or does the § corporation separately state the debt as a short-term capital loss under § 166(d)?

FACTS

X is an § corporation as defined by § 1361 of the Code that reports its income on a calendar year basis. In 1990, X makes a $100x loan to Y which constitutes a nonbusiness debt. X's loan to Y becomes partially worthless in 1993 to the extent of $20x, and X charges off this amount on its books. The balance of the loan, $80x, becomes worthless in 1994, and X charges off the balance in that year.

LAW AND ANALYSIS

§ 166(a)(1) of the Code allows a deduction for any debt that becomes worthless within the tax year. § 166(a)(2) provides that when satisfied that a debt is recoverable only in part, the Secretary may allow the debt as a deduction in an amount not in excess of the part charged off within the tax year.

Under § 166(d)(1) of the Code, concerning a taxpayer other than a corporation, (A) § 166(a) does not apply to any nonbusiness debt, and (B) when any nonbusiness debt becomes worthless within the tax year, the resulting loss is considered a loss from the sale or exchange, during the tax year, of a capital asset held for not more than 1 year.

§ 166(d)(2) of the Code provides that for purposes of § 166(d)(1), the term "nonbusiness debt" means a debt other than (A) a debt created or acquired in connection with a trade or business of the taxpayer, or (B) a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business.

Under § 1366(a)(1) of the Code, in determining the tax under chapter 1 of a shareholder for the shareholder's tax year in which the tax year of the § corporation ends (or for the final tax year of a shareholder who dies before the end of the corporation's tax year), there is taken into account the shareholder's pro rata share of the corporation's (A) items of income (including tax-exempt income), loss, deduction, or credit, the separate treatment of which could affect the liability for tax of any shareholder, and (B) nonseparately computed income or loss. The items referred to in § 1366(a)(1)(A) include amounts described in § 702(a)(4) and (6).

§ 1366(b) of the Code provides that the character of any item included in a shareholder's pro rata share under § 1366(a)(1) is determined as if the item were realized directly from the source from which realized by the corporation or incurred in the same manner as incurred by the corporation.

Under § 1363(b) of the Code, an § corporation's taxable income is generally computed in the same manner as an individual's, except that (A) the items described in § 1366(a)(1)(A) are separately stated, (B) the deductions listed in § 703(a)(2) are not allowed to the corporation, (C) § 248 (relating to organizational expenditures) applies, and (D) § 291 (relating to corporate preference items) applies if the § corporation (or any predecessor) was a C corporation for any of the three immediately preceding tax years. This is consistent with generally taxing § corporation shareholders like partners. S.Rep. No. 640, 97th Cong., 2d Sess. 15 (1982), 1982-2 C.B. 718, 724; H.R.Rep. No. 826, 97th Cong., 2d Sess. 14 (1982), 1982-2 C.B. 730, 736.

§ 166 of the Code is not specifically enumerated as an exception to the general rule of § 1363(b); therefore, § 166 applies in the same manner as it does for an individual when computing an § corporation's taxable income. Thus, an § corporation must (1) include in its separately stated short- term capital loss any wholly worthless nonbusiness debt, and (2) deduct as an ordinary loss any partially or wholly worthless business debt.

In the present situations, X's $100x loan to Y is a nonbusiness debt within the meaning of § 166(d)(2) of the Code. Accordingly, X is not allowed a $20x ordinary loss deduction in its 1993 tax year under § 166(a)(2) when the loan becomes partially worthless. X also is not allowed an $80x ordinary loss deduction in its 1994 tax year under § 166(a)(1) when the loan becomes wholly worthless. Under § 166(d)(1)(B), X includes the $100x nonbusiness bad debt as a short-term capital loss in its 1994 tax year when the loan becomes wholly worthless.

HOLDING

An § corporation, that has a nonbusiness bad debt under § 166 of the Code must separately state the debt as a short-term capital loss under § 166(d).

DRAFTING INFORMATION

The principal author of this revenue ruling is D. Lindsay Russell of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling, contact Mr. Russell on (202) 622-3050 (not a toll-free call).

1993-1 C.B. 187, 1993-19 I.R.B. 4.