Individual Income Tax
S corporation loss in excess of shareholder basis in stock or loans
Subtractions and Exclusions
October 31, 1988
Re: Ruling Request
Individual Income Tax
This is in reply to your letter dated August 15, 1988, in which you request a ruling regarding the proper treatment of certain distributive share items received by a shareholder in an S corporation.
An S corporation operating a business in Virginia incurred losses during taxable years 1983 through 1985, which exceeded the shareholders' basis in capital stock and in loans advanced to the corporation. As a result, no income or loss of the corporation was reportable on the shareholders' federal income tax return. During taxable year 1986 the corporation's deductions again exceeded income. However, due to operating changes, items of income and expense did appear on the shareholders' federal income tax return.
During 1987 the shareholders loaned additional funds to the corporation in order to take advantage of the tax losses which had not been deducted previously. As a result, the shareholders were able to claim a portion of the previously nondeductible losses on their 1987 federal and Virginia returns.
You request a ruling regarding the proper treatment, by the shareholders, of the Virginia addition and subtraction modifications in the years in which the S corporation incurred losses which exceeded the shareholders' basis in capital stock and in loans advanced to the corporation.
Under Internal Revenue Code §1366(d), the aggregate amount of losses and deductions taken into account by a shareholder in an S corporation cannot exceed the shareholder's basis in stock and debt. Any loss or deduction which is not taken into consideration by a shareholder, due to the fact that the loss or deduction exceeds his basis in stock and debt, may be carried over indefinitely.
There is no similar express statutory provision in the Code of Virginia for the carryover of such losses. However, Virginia Code §58.1-322 provides that the starting point for an individual computing Virginia taxable income is federal adjusted gross income. Since the amount of losses and deductions, which exceed the shareholder's basis in stock and debt is not reflected in federal adjusted gross income, such amounts are not reflected in Virginia taxable income. Any loss or deduction carried over is reflected in the federal adjusted gross income of the tax year in which the basis in stock and debt is equal to or exceeds the loss or deduction. Similarly, the amount of loss reflected in federal adjusted gross income in the carryover Year, is reflected in Virginia taxable income in the same year.
Virginia Code §58.1-322 also sets forth certain addition and subtraction modifications which must be made to federal adjusted gross income when computing Virginia taxable income. Generally, the department requires that these modifications be associated with and claimed in the same taxable year as the income to which they relate. [See enclosed Ruling dated May 10, 1988 (Public Document 88-82) and enclosed copy of Virginia Regulation (VR) 630-2-311.1: Individual Income Tax: Net Operating Losses.]
Therefore, with the exception of the Virginia excess cost recovery modifications (see below), the Virginia addition and subtraction modifications for a tax year in which the S corporation loss is not reflected in federal adjusted gross income will follow the loss to the year in which the loss is utilized. The sum of the Virginia modifications will be applied in the same proportion as the amount of loss that is utilized. Thus, if for federal purposes, the loss is fully reflected in federal adjusted gross income in a carryforward year, the entire net amount of Virginia modifications will be applied to such year. If, however, the loss is partially reflected in federal adjusted gross income in each of several years, the net Virginia modifications will be applied in the same ratio to the several years.
The excess cost recovery modifications (or ACRS additions and subtractions) for taxable years beginning before January 1, 1988, must be reported by each shareholder regardless of whether or not losses are limited. See Ruling of the Commissioner dated February 27, 1987, P.D. 87-83, (copy enclosed).
Based upon the information that you provided in your ruling request, it appears that the shareholders properly filed their 1983-1985 Virginia returns. However, to the extent that any amount of the S corporation loss for taxable years 1983-1985 was reflected in the shareholders' federal adjusted gross income in taxable years 1986 or 1987, an adjustment for the Virginia modifications associated with the S corporation loss should have been made. Virginia Code §58.1-1823 provides that a taxpayer may file an amended return within three years from the last day prescribed by law for the timely filing of the return or within sixty days for the final determination of a change at the federal level.
If you have any further questions, please do not hesitate to contact the department.
W. H. Forst