Why separately stated and nonseparately stated income

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. 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 -. 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 ;.

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 paragraph a 2 of this section.

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 paragraphs a 2 and 3 of this section for each of the corporation 's activities as defined in section and the regulations thereunder. 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.

Actual distributions in a given year may be more or less than the distributive share reported by the partner. The partnership agreement generally determines how a partner shares in the income and losses of the partnership. The interest may be as a single percentage or it may indicate profit and loss interests as separate percentages.

Thus, a partnership agreement may state that a partner has a 10 percent interest in both partnership profits and losses or a partner has a 10 percent interest in partnership profits but a 30 percent interest in partnership losses.

If profit and loss percentages are stated separately, the partnership's taxable income for the year is first totaled to determine whether a net profit or net loss has been earned. Then the appropriate percentage either profit or loss is applied to each class of income for the year.

If none of these conditions are met, the IRS will reallocate the partner's income and losses according to the partners interest in the partnership as determined by the Service. The rules for special allocations will be discussed thoroughly in the Module on Allocations.

The allocation is in accordance with the partner's interest in the partnership. Z is a 30 percent partner who works for the partnership. The partnership's records show.

Z must report on his tax return. The amount of partnership losses that a partner can deduct including capital losses is limited by Section d to the basis of the partners interest at the end of the partnership year. A partner's share of partnership losses in excess of basis is disallowed in the current year and must be carried forward to be deducted in future years when the partners basis increases. The Regulations detail how the limitation is applied to different types of partnership losses:.

The character of any excess losses is preserved when the losses are carried forward. In addition, any losses carried forward from the prior year must be aggregated with the current year losses before the limitation of Section d is applied.

The Regulations provide that any disallowed or suspended losses may be deducted in a subsequent year to the extent of the partner's adjusted basis at the end of the subsequent year. There is no time restriction on the carryforward period.

As a result, an excess loss may be allowable in any subsequent year that a partner makes a capital contribution, accumulates income or increases the partnership interest. Upon a sale or exchange of a partnership interest, if any suspended losses exist, the selling partner is not entitled to take the previously disallowed losses, and the selling partner's basis remains at zero for gain computation purposes.

Although the Code or Regulations do not specifically indicate, it seems apparent that the excess carryforwards should not be transferable to the purchasing partner. This is because the gain recognized is computed from a zero basis and not a negative basis that would have occurred if the disallowed loss had been recognizable.

If partnership losses are projected for a given year, careful tax planning can ensure the deductibility of a partner's entire distributive share of such loss. Current year partnership losses can be deducted in a given year if a calendar year partner makes an additional capital contribution by December Likewise, if the partnership incurs additional debt before year-end, it would operate to increase the partners basis and allow a deduction for the potential suspended loss.

Note, however, that other provisions may cause a limitation in the deduction e. These provisions are discussed in Module G. Although a partner may have sufficient basis to claim a loss, at risk limitations may restrict a partner from deducting losses where there is no financial risk of loss.

IRC Sec. A partner's at-risk amount generally includes his adjusted basis in the partnership taking into account only those liabilities for which the partner has personal liability. This is in contrast to a partner's outside basis computation which may include the partner's share of all partnership liabilities without regard to any personal liability on the obligations, Thus, a partners outside basis may include both recourse and nonrecourse liabilities, while the same partner's at risk basis would only include recourse liabilities.

With respect to liabilities, neither general nor limited partners are considered to be at risk with respect to liabilities for which the partner is protected against loss through nonrecourse financing, guarantees, or similar arrangements. Ordinarily, nonrecourse liabilities are not included in the at-risk basis. However, after , qualified nonrecourse financing is included in a partner's at-risk amount.

Qualified nonrecourse financing generally means any loan from a qualified lender that is secured by real property and borrowed for the purpose of owning the real property. Limited partners are not at-risk for any liabilities of the partnership except to the extent of their capital contributions. Consequently, additional partnership liabilities will not increase their amount at risk.

There may be instances where, pursuant to the partnership agreement, the limited partner is obligated to make additional capital contributions to the partnership. Such amounts are included in the partner's basis but generally are not included in the at-risk amount until actually contributed. Deductions disallowed due to at-risk limitations carry over to subsequent years and are deductible whenever sufficient at-risk amounts are established.

There is no limit to the number of years to which a taxpayer may carry over such disallowed deductions. Passive loss limitations Code Section provides that income as well as losses are classified into three separate categories:. Partners who are designated as passive owners are limited in the amount of losses and credits that they can deduct.

Nonseparately stated income for Alabama S corporations will be computed in the same manner as for individuals, except for those deductions and exemptions which are not applicable to nonindividuals, such as:. Certain items of income, loss and deductions are to be passed through to the individual returns of the shareholders, rather than being deducted in computing the nonseparately stated income of the S corporation on the Alabama S corporation return. Separately stated items are those the separate treatment of which could affect the liability for tax of any shareholder.

These items include:. These items classified as "nonbusiness" for Alabama net operating loss deduction purposes are usually classified as "portfolio income and expense" on the federal S corporation return and supporting schedules. The yearly losses, if any, of the S corporation are passed through to the shareholders, and thus are not available at the corporate level for carryforward. Any losses incurred by a corporation in any years in which the corporation was not an Alabama S corporation, may not be carried forward to any years in which the corporation is an Alabama S corporation.

This definition includes only income taxes described in Sec. These rules mean that specified income tax payments paid as state and local income taxes imposed on and paid by a partnership or an S corporation on its income are allowed as a deduction by the partnership or S corporation in computing its non—separately stated taxable income or loss for the tax year of payment.

The IRS did not provide a timetable for issuing the proposed regulations but said they will apply to specified income tax payments made on or after Nov. The proposed regulations will also permit a deduction for payments made by a partnership or S corporation for tax years ending after Dec.

Schreiber , J. Schreiber aicpa-cima.