## Facts

- David Gitlitz and Philip Winn were shareholders of an insolvent S corporation, P.D.W. & A., Inc.
- In 1991, the corporation realized discharge-of-indebtedness (DOI) income.
- Because the corporation was insolvent, it excluded the DOI from gross income under I.R.C. § 108(a).
- The shareholders treated their pro rata shares of the excluded DOI as pass-through “items of income” under § 1366 and increased their stock bases under § 1367(a)(1)(A).
- Using the increased bases, the shareholders deducted current and previously suspended S-corporation losses on their individual returns.
- The Commissioner disallowed the deductions, asserting excluded DOI could not increase shareholder basis.
- The Tax Court ruled for the Commissioner; the Tenth Circuit affirmed, holding § 108(b) attribute reduction occurred first, leaving no DOI to pass through.
- The Supreme Court granted certiorari to resolve whether excluded DOI passes through and, if so, the sequencing relative to § 108(b).

## Issues

1. Whether DOI excluded from gross income under I.R.C. § 108(a) remains an “item of income” that passes through to S-corporation shareholders under § 1366 and increases stock basis under § 1367.
2. If it passes through, whether the shareholder basis increase occurs before or after the S corporation reduces its tax attributes under § 108(b).

## Decision

- The Supreme Court reversed the Tenth Circuit and remanded.
- Excluded DOI is an “item of income” within § 1366(a)(1)(A) and therefore passes through to shareholders and increases basis under § 1367(a)(1)(A).
- The basis increase and pass-through occur before the corporation’s § 108(b) attribute reductions.
- The Court relied on the statutory text: § 108(a) excludes DOI from gross income but does not eliminate its character as an item of income, and § 108(b)(4)(A) requires attribute reduction “after” determining the tax for the year of discharge, which for S-corporation shareholders requires basis adjustments and pass-through computations.

## Legal Principles

- DOI is included in gross income under § 61(a)(12) unless excluded; an exclusion under § 108(a) removes DOI from gross income but does not, by itself, strip DOI of its status as an “item of income” for Subchapter S purposes.
- Under § 1366 and § 1367, S-corporation shareholders take into account pro rata “items of income (including tax-exempt income)” and correspondingly increase basis by those income items.
- For excluded DOI in an insolvent S corporation, § 108(b) attribute reduction is sequenced by § 108(b)(4)(A) to occur after the tax for the discharge year is determined; because determining shareholder tax requires pass-through and basis adjustments, the DOI basis increase precedes attribute reduction.
- Policy concerns about untaxed DOI producing additional loss deductions do not override unambiguous statutory text; changes to such outcomes are for Congress.

## Conclusion

The Court held that excluded discharge-of-indebtedness income of an insolvent S corporation passes through to shareholders as an item of income, increases their stock basis, and does so before any corporate tax-attribute reduction under § 108(b), permitting shareholders to use the basis increase to claim otherwise limited losses.


Gitlitz v. Commissioner, 531 U.S. 206 (2001)