## Facts

- George W. and Corinna Jane Wiebusch operated a sole proprietorship and transferred its business assets to a newly formed corporation, L & C, solely in exchange for all of its stock.
- The transfer was intended to qualify for nonrecognition under I.R.C. § 351, with the Wiebusches in control immediately after the exchange.
- The transferred assets were encumbered by liabilities that exceeded the assets’ aggregate adjusted basis; L & C assumed those liabilities.
- Because assumed liabilities exceeded basis, the Wiebusches recognized gain under I.R.C. § 357(c) at incorporation, which increased their stock basis under the exchange basis rules.
- L & C elected Subchapter S status and reported net operating losses in each of its first three taxable years.
- The Wiebusches claimed deductions on their individual returns for their pro rata shares of L & C’s losses.
- The Commissioner disallowed the claimed loss deductions to the extent they exceeded allowable shareholder basis and issued deficiencies.

## Issues

1. Whether a shareholder’s stock basis increase attributable to gain recognized under I.R.C. § 357(c) in a § 351 incorporation permits deduction of later S-corporation losses passed through to the shareholder.
2. Whether Subchapter S loss limitation rules restrict loss deductions notwithstanding a statutory increase in stock basis from § 357(c) gain.

## Decision

- The Tax Court sustained the Commissioner’s deficiency determinations and limited the Wiebusches’ deductible S-corporation losses under the Subchapter S basis rules.
- The court treated § 357(c) gain as recognized taxable gain that increases stock basis under the Code’s basis provisions.
- Nonetheless, the court held that Subchapter S loss limitations independently govern how much of the corporation’s losses shareholders may deduct.
- The U.S. Court of Appeals for the Eighth Circuit affirmed per curiam on the Tax Court’s reasoning.

## Legal Principles

- In a § 351 exchange, if liabilities assumed by the corporation exceed the aggregate adjusted basis of property transferred, the excess is recognized as gain under I.R.C. § 357(c).
- Recognized gain in a § 351 transaction increases the transferor’s basis in the stock received under the stock basis computation rules (including I.R.C. § 358).
- An S-corporation shareholder’s pass-through loss deductions are limited to the shareholder’s adjusted basis in S-corporation stock plus qualifying indebtedness of the corporation to the shareholder (not merely third-party corporate liabilities).
- A statutory basis increase from § 357(c) gain does not negate or supersede Subchapter S loss limitation provisions; those limitations continue to cap deductible losses.

## Conclusion

The Tax Court held that although § 357(c) gain recognized when liabilities exceed basis increases a shareholder’s stock basis in a § 351 incorporation, S-corporation loss deductions remain limited by the Subchapter S basis rules; the Commissioner properly disallowed losses exceeding the allowable shareholder basis.


Wiebusch v. Commissioner, 59 T.C. 777 (1973)