IRS 07/03 Ruling

UNITED STATES TAX COURT

WASHINGTON, DC 20217

Docket No. 7873-01

ALPHONSE MOURAD,

Petitioner

COMMISSIONER OF INTERNAL REVENUE,

Respondent

DECISION

Pursuant to the determination of the Court, as set forth in its Opinion (121 T.C. No. 1), filed July 2, 2003, it is ORDERED AND DECIDED: That there is a deficiency in income tax due from petitioner for the taxable year 1997 in the amount of $189,745.

Robert P. Ruwe

Judge

ENTERED: July 3, 2003

121 T.C. No. 1

UNITED STATES TAX COURT

ALPHONSE MOURAD,

Petitioner

COMMISSIONER OF INTERNAL REVENUE,

Respondent

Docket No. 7873-01. Filed July 2, 2003.

In 1996, P's wholly owned S corporation filed a

petition for bankruptcy reorganization. The U.S.

Bankruptcy Court appointed an independent trustee to

administer the bankruptcy estate. In 1997, a plan of

reorganization was confirmed, and the S corporation

sold its principal assets. The bankruptcy trustee

filed a Form 1120S for the S corporation's 1997 tax

year, which reported a large gain. P failed to file

his individual income tax return for 1997. From

information disclosed by the S corporation on its 1997

return, R determined P's income and issued a notice of

deficiency.

Held: The filing of a bankruptcy petition for

reorganization neither terminates an S corporation's

tax status nor creates a separate taxable entity. P is

liable for tax on the income of the S corporation.

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1Respondent objected to many of the exhibits on the basis of

relevancy and/or hearsay. Even if we accept those exhibits, they

would have no effect on our findings of fact or the outcome of

this case.

Held, further, P failed to follow the procedures

necessary to claim low-income housing tax credits.

Held, further, statements made by R's

representative at a bankruptcy plan confirmation

hearing did not waive R's determination that P owes

income taxes for 1997.

Alphonse Mourad, pro se.

Steven M. Carr, for respondent.

RUWE, Judge: Respondent determined a $189,745 income tax

deficiency for petitioner's 1997 tax year. The issues presented

to the Court are: (1) Whether petitioner should be taxed on gain

from the sale of assets by his S corporation during the

corporation's bankruptcy proceeding; (2) whether petitioner is

entitled to low-income housing tax credits; and (3) whether

respondent waived his claims for payment of petitioner's 1997

income tax.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

The stipulation of facts, the second stipulation of facts, and

the accompanying exhibits are incorporated herein by this

reference.1 At the time the petition was filed, petitioner

resided in Massachusetts.

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2Petitioner is also listed as owning 100 percent of V&M

Management on its 1998 and 1999 Forms 1120S, U.S. Income Tax

Return for an S Corporation. V&M Management elected to be taxed

as an S corporation on Jan. 1, 1984.

3V&M Management d.b.a. Vasquez Development Co., Inc.,

acquired title to Mandela Apartments from the Secretary of

Housing and Urban Development on Dec. 11, 1981.

During the year at issue, petitioner was the sole

shareholder of V&M Management, Inc., an S corporation (V&M

Management).2 V&M Management owned and operated a 275-unit

apartment complex known as Mandela Apartments in Roxbury,

Massachusetts.3

On January 8, 1996, V&M Management filed a petition for

reorganization pursuant to chapter 11 of the U.S. Bankruptcy Code

in the U.S. Bankruptcy Court, District of Massachusetts, Boston.

The bankruptcy court appointed an independent trustee, Stephen S.

Gray (the bankruptcy trustee), to administer the reorganization.

In the bankruptcy action, the Commissioner filed proofs of claim

for employment taxes due and owing by V&M Management.

On September 26, 1997, the bankruptcy court confirmed a plan

of reorganization (the plan). The cornerstone of the plan was

the sale of Mandela Apartments and its related property. Because

the plan called for full payment of the employment taxes owed by

V&M Management, the Commissioner had no objection to the plan.

On or about December 18, 1997, the bankruptcy trustee sold

Mandela Apartments and its related property for $2,872,351.

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4V&M Management's 1997 return was signed by the bankruptcy

trustee on Sept. 1, 1998.

5The 1997 Schedule K-1 indicates that $1,794,602 was a net

sec. 1231 gain and $293,952 was a net long-term capital gain.

6Respondent carried forward an interest expense deduction of

$965,226 and a net operating loss of $433,167. Additionally,

respondent allowed $4,150 as a standard deduction.

On behalf of V&M Management, the bankruptcy trustee prepared

and filed Forms 1120S, U.S. Income Tax Return for an S

Corporation, for tax years 1995 through 1999.4 The 1997 Schedule

K-1, Shareholder's Share of Income, Credits, Deduction, etc.,

reported that petitioner realized a gain of $2,088,554 from the

sale of the Mandela Apartments' property.5

Petitioner did not file individual income tax returns for

1996 and 1997. On August 13, 2001, respondent issued a notice of

deficiency for the 1997 tax year, which determined that

petitioner received income of $2,088,554. Respondent's

determination was based on information reported on V&M

Management's 1997 Schedule K-1. In determining the amount of

petitioner's deficiency, respondent allowed deductions of

$1,402,543.6 Respondent determined that petitioner owed $189,745

in income taxes for 1997.

V&M Management has never claimed low-income housing credits

on any of its returns. V&M Management never applied for an

allocation of low-income housing credits and never received Form

8609, Low-Income Housing Credit Allocation Certification, from

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7Except as indicated to the contrary, all section references

are to the Internal Revenue Code for the year in issue.

the State of Massachusetts. Neither V&M Management nor

petitioner ever attached Form 8609 to their tax returns.

Petitioner never claimed low-income housing credits on his

personal returns for the years during which V&M Management owned

Mandela Apartments.

OPINION

A. Income Imputed From the S Corporation

Petitioner does not question respondent's calculation of

income. Rather, petitioner argues that he should not be treated

as a shareholder of an S corporation after V&M Management filed a

petition with the bankruptcy court.

One of the benefits of S corporation tax status is that

income earned by the entity escapes corporate-level taxation.

See sec. 1363.7 Thus, an S corporation's income passes through

the entity and is, generally, taxed only at the shareholder level

on a pro rata basis. See secs. 1363, 1366.

An election to be an S corporation continues until

terminated. See sec. 1362(d). An S corporation election

terminates in one of three ways: (1) Revocation by the

shareholder(s); (2) the entity ceases to be a "small business

corporation"; or (3) the entity's passive income exceeds 25

percent of its gross receipts for the previous 3 consecutive

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years. See id. The Code provides only these three ways by which

the S corporation election may be terminated. See sec. 1362(d).

Petitioner makes no claim that either the first or third method

of termination applies. Thus, we must determine whether the

filing of the chapter 11 bankruptcy petition terminates V&M

Management's status as a "small business corporation". Section

1361(b) provides in part:

SEC. 1361(b). Small Business Corporation.--

(1) In general.--For purposes of this subchapter,

the term "small business corporation" means a domestic

corporation which is not an ineligible corporation and

which does not--

(A) have more than 75 shareholders,

(B) have as a shareholder a person (other

than an estate and other than a trust described in

subsection (c)(2)) who is not an individual,

(C) have a nonresident alien as a

shareholder, and

(D) have more than 1 class of stock.

Section 1361(b)(2) describes an "ineligible corporation" as:

any corporation which is--

(A) a financial institution which uses the

reserve method of accounting for bad debts

described in section 585,

(B) an insurance company subject to tax under

subchapter L,

(C) a corporation to which an election under

section 936 applies, or

(D) a DISC or former DISC.

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The filing of the bankruptcy petition had no impact on V&M

Management's qualification as a "small business corporation"

under section 1361(b). Petitioner was the only shareholder of

V&M Management during the year in issue and remained the only

shareholder through 1999.

Neither party cites any previous court opinions that have

decided whether or not an S corporation's status is terminated by

virtue of filing a chapter 11 petition in bankruptcy. This

appears to be an issue of first impression.

The issue of whether the filing of a bankruptcy petition

causes the termination of an S corporation's status was addressed

in In re Stadler Associates, Inc., 186 Bankr. 762 (Bankr. S.D.

Fla. 1995). In that case, the sole shareholder of the debtor

corporation contended that the filing of a bankruptcy petition

terminates S corporation status since the shareholder lost

control of the debtor. Disagreeing, the bankruptcy court held

that the filing of a petition in bankruptcy does not cause the

corporation to cease to be a "small business corporation" or

otherwise terminate the S corporation status. The bankruptcy

court held that "rules of statutory construction prohibit this

Court from adding a fourth method of terminating an S corporation

election where the Internal Revenue Code clearly sets forth the

aforementioned three methods". Id. at 764. We agree.

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8See also 11 U.S.C. sec. 346(c) (2000) ("The commencement of

a case under this title concerning a corporation or a partnership

does not effect a change in the status of such corporation or

partnership for the purpose of any State or local law imposing a

tax on or measured by income.").

In re Stadler Associates, Inc. involved a voluntary petition

under chapter 7 of the Bankruptcy Code. In this case, V&M

Management filed a voluntary petition under chapter 11 of the

Bankruptcy Code. Although the remedies sought in a chapter 7

liquidation proceeding are different from those in a chapter 11

reorganization proceeding, this difference does not affect

application of the rationale stated in In re Stadler Associates,

Inc. to both types of bankruptcy proceedings.

Likewise, no new or separate taxable entity was created by

the filing of the bankruptcy petition. Section 1399 provides:

"Except in any case to which section 1398 applies, no separate

taxable entity shall result from the commencement of a case under

title 11 of the United States Code." Section 1398 is

inapplicable since it applies exclusively to individuals. The

legislative history explains:

The bill provides that no taxable entity results

from commencement of a bankruptcy case involving a

partnership or corporation. This rule * * * reverses

current Internal Revenue Service practice as to

partnerships, under which the estate of a partnership

in bankruptcy is treated as a taxable entity (Rev. Rul.

68-48, 1968-1 C.B. 301) * * * [H. Rept. 96-833, at 20-

21 (1980).8]

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9Accord Schindler v. Walker (In re Harbor Village Dev.), 75

AFTR 2d 95-508, 95-1 USTC par. 50,032 (Bankr. D. Mass. 1994)

(partners, and not bankrupt partnership, were liable for taxes

from income generated while partnership in ch. 11 bankruptcy).

We hold that a bankruptcy petition filed by an S corporation

does not cause the corporation to cease being a "small business

corporation" or otherwise terminate its status as an S

corporation. The tax treatment of the S corporation is the same

whether or not the entity filed for bankruptcy.9

Petitioner argues that it is unfair to tax him on

passthrough income earned by his solely owned S corporation while

it was in chapter 11 bankruptcy reorganization because he

"received no actual benefit from the use of the property". We

disagree. Since electing S corporation status, petitioner has

enjoyed passthrough, one-level taxation and corporate liability

protection. V&M Management's income tax returns show that over

the years petitioner had substantial income from V&M Management

and that the S corporation's business property was depreciated,

thus reducing the amount of petitioner's taxable income.

Furthermore, petitioner testified that he was personally liable

for the debts of V&M Management. The proceeds from the sale of

Mandela Apartments reduced V&M Management's debt liability. See

Schindler v. Walker (In re Harbor Village Dev.), 75 AFTR 2d 95-

508, 95-1 USTC par. 50,032 (Bankr. D. Mass. 1994) ("the income

[while in bankruptcy] will be used to satisfy claims of the

Debtor's creditors"). Since no separate taxable entity was

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created when V&M Management filed for bankruptcy and the S

corporation status was not otherwise terminated, the passthrough

treatment of V&M Management's income realized during bankruptcy

is correctly imputed to petitioner.

B. Low-Income Housing Credit

Petitioner argues in the alternative that if the S

corporation status of V&M Management is not terminated by the

filing of a bankruptcy petition, he is entitled to low-income

housing credits which offset his income tax liability generated

from the sale of Mandela Apartments. Section 38 provides for a

general business credit, which includes a low-income housing

credit. Section 42 describes the method and manner taxpayers

must use to compute their low-income housing credit. Petitioner

failed to claim the credit while V&M Management owned the

property for which he seeks the credit. Only now, after the

purported qualifying property has been sold, does petitioner seek

a credit.

Petitioner's failure to comply with any of the procedures

and requirements stated in the statutes and regulations granting

the low-income housing credit makes him ineligible for it. To be

eligible for low-income housing credits, a taxpayer must first

obtain permission from the appropriate State or local agency.

See sec. 42(h); sec. 1.42-1T(a)(2), Temporary Income Tax Regs.,

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10The credit-seeking taxpayer must similarly complete Part

II of Form 8609. See sec. 1.42-1T(h)(2), Temporary Income Tax

Regs., 52 Fed. Reg. 23439 (June 22, 1987).

52 Fed. Reg. 23432 (June 22, 1987) ("Generally, the low income

housing credit determined under section 42 is allowed and may be

claimed for any taxable year if, and to the extent that, the

owner of a qualified low income building receives a housing

credit allocation from a State or local housing credit agency.").

As the regulations explain, the taxpayer is not entitled to a

low-income housing credit "in any year in excess of an effective

housing credit allocation received from a State or local housing

credit agency." Sec. 1.42-1T(e)(1), Temporary Income Tax Regs.,

52 Fed. Reg. 23437 (June 22, 1987); see sec. 42(h). "Housing

credit allocations are deemed made when Part I of IRS Form 8609,

Low-Income Housing Credit Allocation Certification, is completed

and signed by an authorized officer of the housing credit

agency".10 Sec. 1.42-1T(d)(8), Temporary Income Tax Regs., 52

Fed. Reg. 23437 (June 22, 1987). Furthermore, the taxpayer must

file a completed Form 8609 and a Form 8586, Low-Income Housing

Credit, with his tax return for each year the credit is claimed.

Sec. 1.42-1T(h)(2), Temporary Income Tax Regs., 52 Fed. Reg.

23439 (June 22, 1987). Neither V&M Management nor petitioner

ever applied for an allocation of low-income housing credits,

received Form 8609, or attached Form 8609 to its or his tax

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return. Under these circumstances petitioner is ineligible for

low-income housing credits.

C. Alleged Waiver of Petitioner's Income Taxes

Lastly, petitioner argues that respondent "waived all claims

for payment [of taxes] * * * at the September 26, 1997 bankruptcy

court confirmation hearing." At the plan confirmation hearing,

counsel for the Commissioner withdrew a previous objection

because the confirmed plan called for the full payment of

employment taxes due and owing by V&M Management. There were no

claims against V&M Management for income tax liabilities because

an S corporation is not generally liable for income tax.

We agree with respondent that petitioner is obviously

confusing V&M Management with himself. The record demonstrates

that V&M Management, and not petitioner, filed a petition for

reorganization in bankruptcy. The Commissioner filed proofs of

claim in the bankruptcy case for unpaid employment taxes. It was

these taxes, owed by V&M Management, which were at issue in the

bankruptcy proceeding. A plan of reorganization was confirmed by

the bankruptcy court to which the Commissioner had no objection.

In contrast, here, petitioner filed a petition seeking

redetermination of a deficiency of income taxes determined

against him. V&M Management is not a party to these proceedings.

Although the amount of the deficiency that respondent determined

is directly related to the sale of the Mandela Apartments by V&M

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Management, the statements respondent's representative made

during the bankruptcy confirmation hearing did not refer to, and

had no effect on, petitioner's income tax liability for the year

at issue. Accordingly, we hold that respondent did not waive his

claim that petitioner owes income tax for 1997.

D. Conclusion

The filing of a bankruptcy petition does not terminate V&M

Management's S corporation election, and the income of V&M

Management is taxable to petitioner. Petitioner is not entitled

to low-income housing tax credits for 1997, and respondent did

not waive any claim that petitioner is liable for income tax for

the year 1997.

Decision will be entered for

respondent.

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