No. 99-1693
In the Supreme Court of the United States
WILLIAM C. WITZEL AND GENE E. WITZEL, PETITIONERS
v.
COMMISSIONER OF INTERNAL REVENUE
ON PETITION FOR A WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE SEVENTH CIRCUIT
BRIEF FOR THE RESPONDENT
SETH P. WAXMAN
Solicitor General
Counsel of Record
PAULA M. JUNGHANS
Acting Assistant Attorney
General
TERESA E. MCLAUGHLIN
EDWARD T. PERELMUTER
Attorneys
Department of Justice
Washington, D.C. 20530-0001
(202) 514-2217
QUESTION PRESENTED
Petitioner William C. Witzel was the sole shareholder in a Subchapter S
corporation that obtained a discharge of indebtedness in a bankruptcy proceeding.
That discharge would have been treated as an item of "[i]ncome from
discharge of indebtedness" (26 U.S.C. 61(a)(12)) except that, because
the discharge occurred during a bankruptcy proceeding, the item is expressly
"not include[d] * * * in gross income" under 26 U.S.C. 108(a)(1)(A).
The question presented in this case is whether the amount thus expressly
excluded from "income" is nonetheless to be treated as if it were
an item of "income" which, under 26 U.S.C. 1366(a)(1)(A), flows
through to petitioner as the shareholder of the Subchapter S corporation,
thereby increasing his basis in the stock of the corporation under 26 U.S.C.
1367(a)(1)(A), and thereby allowing him to deduct losses he previously was
unable to deduct because he had exhausted his basis by prior deductions.
In the Supreme Court of the United States
No. 99-1693
WILLIAM C. WITZEL AND GENE E. WITZEL, PETITIONERS
v.
COMMISSIONER OF INTERNAL REVENUE
ON PETITION FOR A WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE SEVENTH CIRCUIT
BRIEF FOR THE RESPONDENT
OPINIONS BELOW
The opinion of the court of appeals (Pet. App. 1a-6a) is reported at 200
F.3d 496. The memorandum opinion of the Tax Court (Pet. App. 8a-11a) is
unofficially reported at 77 T.C.M. (CCH) 1487.
JURISDICTION
The judgment of the court of appeals was entered on January 18, 2000. The
petition for a writ of certiorari was filed on April 17, 2000. The jurisdiction
of this Court is invoked under 28 U.S.C. 1254(1).
STATEMENT
1. a. During the 1993 taxable year, petitioner William C. Witzel was the
sole shareholder of Water Products Co. of Illinois, Inc., a corporation
that had elected to be taxed under the provisions of Subchapter S of the
Internal Revenue Code, 26 U.S.C. 1361-1379. Pet. App. 9a. As this Court
explained in Bufferd v. Commissioner, 506 U.S. 523, 525 (1993), Subchapter
S of the Code implements "a pass-through system under which corporate
income, losses, deductions, and credits are attributed to individual shareholders
in a manner akin to the tax treatment of partnerships."
In 1991, Water Products filed a petition for relief under Chapter 11 of
the Bankruptcy Code. Pet. App. 9a. In 1992, debts of that corporation totaling
$5,404,323 were discharged by the bankruptcy court. Ibid. The discharge
of these debts would have represented "[i]ncome from discharge of indebtedness"
to the corporation (26 U.S.C. 61(a)(12)) but for the fact that the discharge
occurred in a bankruptcy proceeding. Because the discharge occurred in a
bankruptcy proceeding, it was expressly excluded from income under Section
108 of the Code, which specifies that "[g]ross income does not include
any amount which * * * would be includible in gross income by reason of
the discharge * * * of indebtedness of the taxpayer if * * * the discharge
occurs in a title 11 case." 26 U.S.C. 108(a)(1)(A).
b. Although Section 108 of the Code thus specifies that discharge of indebtedness
is not an item of income when the discharge occurs in a federal bankruptcy
proceeding, petitioners claim that it should nonetheless be treated as if
it were an item of income for purposes of Sections 1366 and 1367 of the Code. Those provisions determine various aspects
of the tax treatment of shareholders of a Subchapter S corporation. In particular,
they specify that "items of income (including tax-exempt income), loss,
deduction, or credit" pass through to the shareholders (26 U.S.C. 1366(a)(1)(A)),
that the "items of income" that pass through to the shareholders
increase the shareholders' basis in the stock of the Subchapter S corporation
(26 U.S.C. 1367(a)(1)(A)), that the losses and deductions that pass through
reduce the shareholders' stock basis (26 U.S.C. 1367(a)(2)(B)), and that
distributions of earnings or assets of the corporation to the shareholders
reduce their basis in the stock (26 U.S.C. 1367(a)(2)(A)). The basic concepts
reflected in these provisions are: (i) that the income earned (or loss incurred)
at the corporate level is treated as if it were earned (or lost) at the
individual level; and (ii) that basis adjustments are made to avoid a double
tax on those earnings or a double benefit from those losses.
A shareholder may deduct losses only to the extent that he has not previously
recovered (through prior deductions) his basis in the stock. 26 U.S.C. 1366(d)(2).
In this case, petitioner William Witzel had previously deducted losses representing
his entire basis in the corporate stock. At the time the indebtedness of
the Subchapter S corporation was discharged in 1992, petitioner would thus
be allowed further deductions from the corporation's losses only if his
basis in the stock of the corporation were somehow increased.1
Petitioner asserts that the additional basis that would allow him to take
further deductions from prior corporate losses can be found in the discharge
of indebtedness "income" of the corporation in 1992. He contends
that this discharge of indebtedness is an "item[] of income" (26
U.S.C. 1366(a)(1)(A)) which increases his basis in the corporate stock (under
26 U.S.C. 1367(a)(1)(A)) even though, for the reasons described above, Section
108(a) of the Code expressly states that this is "not" an item
of income. Petitioner (and his wife on their joint return) thus claimed
a loss deduction of $2,549,251 for the 1993 taxable year that reflected
a carry forward of the losses incurred by Water Products in prior years.
Pet. App. 10a.
The Commissioner of Internal Revenue determined that petitioner was not
entitled to increase his stock basis by the discharge of indebtedness that
was "not" an item of income under Section 108 of the Code. The
Commissioner therefore disallowed the claimed deductions and asserted a
deficiency in tax against petitioners for the 1993 taxable year. Pet. App.
22a-24a.
2. Petitioners filed a petition in Tax Court to contest the Commissioner's
determination. Pet. App. 18a-21a. The Tax Court held that the discharge
of indebtedness that occurred during the bankruptcy proceeding did not increase
petitioner's basis in the corporate stock and that the asserted deductions
were therefore properly denied. Id. at 8a-11a. In reaching that conclusion,
the court relied on the reviewed Tax Court decision in Nelson v. Commissioner,
110 T.C. 114 (1998), aff'd, 182 F.3d 1152 (10th Cir. 1999), in which the
court unanimously held that an amount excluded from an insolvent Subchapter
S corporation's gross income under Section 108 does not increase a shareholder's
basis in the corporate stock. Pet. App. 10a-11a.
3. The court of appeals affirmed. Pet. App. 1a-6a. The court noted that
petitioners were seeking a double tax benefit from the amount excluded from
Water Products' gross income-nonpayment of tax on the excluded amount plus
use of that amount to obtain deductions for otherwise nondeductible suspended
losses. Id. at 3a. The court concluded that it was "preferable"
to interpret Section 108 to preclude that result. Id. at 4a.
DISCUSSION
This case presents the same question presented in Gitlitz v. Commissioner,
No. 99-1295, in which this Court granted the petition for a writ of certiorari
on May 1, 2000. The petition in this case should therefore be held and disposed
of as appropriate in light of the Court's disposition of Gitlitz.2
CONCLUSION
The petition for a writ of certiorari should be held and disposed of as
appropriate in light of the Court's disposition of Gitlitz v. Commissioner,
No. 99-1295.
Respectfully submitted.
SETH P. WAXMAN
Solicitor General
PAULA M. JUNGHANS
Acting Assistant Attorney
General
TERESA E. MCLAUGHLIN
EDWARD T. PERELMUTER
Attorneys
MAY 2000
1 The losses of the corporation incurred prior to and during 1992, which
petitioner had been unable to deduct because he had exhausted his basis
in the stock of the corporation, are described as "suspended"
losses and are carried into future years. They may be deducted in future
years only if the shareholder acquires a basis in the stock to apply against
them. 26 U.S.C. 1366(d)(2).
2 We have provided herewith to petitioners a copy of the brief filed on
behalf of the Commissioner in response to the petition for a writ of certiorari
in the Gitlitz case.