Commissioner v. Indianapolis Power & Light Co.

U.S. Supreme Court CIR v. Indianapolis P & L, 493
U.S. 203 (1990) Commissioner of Internal Revenue
v. Indianapolis Power & Light
Company No. 88-1319 Argued Oct. 31, 1989 Decided Jan. 9, 1990 493
U.S. 203 CERTIORARI TO THE UDNITED STATES
COURT OF APPEALS FOR THE SEVENTH CIRCUIT Syllabus Respondent Indianapolis Power and Light Co. (IPL), a regulated
Indiana utility and an accrual-basis taxpayer, requires customers
having suspect credit to make deposits with it to assure prompt
payment of future electric bills. Prior to termination of service,
customers who satisfy a credit test can obtain a refund of their
deposits or can choose to have the amount applied against future
bills. Although the deposits are at all times subject to the
company's unfettered use and control, IPL does not treat them as
income at the time of receipt, but carries them on its books as
current liabilities. Upon audit of IPL's returns for the tax years
at issue, petitioner Commissioner of Internal Revenue asserted
deficiencies, claiming that the deposits are advance payments for
electricity and therefore are taxable to IPL in the year of
receipt. The Tax Court ruled in favor of IPL on its petition for
redetermination, holding that the deposits' principal purpose is to
serve as security rather than as prepayment of income. The Court of
Appeals affirmed. Held: The customer deposits are not advance payments
for electricity, and therefore do not constitute taxable income to
IPL upon receipt. Although IPL derives some economic benefit from
the deposits, it does not have the requisite "complete dominion"
over them at the time they are made, the crucial point for
determining taxable income. IPL has an obligation to repay the
deposits upon termination of service or satisfaction of the credit
test. Moreover, a customer submitting a deposit makes no commitment
to purchase any electricity at all. Thus, while deposits eventually
may be used to pay for electricity by virtue of customer default or
choice, IPL's right to retain them at the time they are made is
contingent upon events outside its control. This construction is
consistent with the Tax Court's longstanding treatment of sums
deposited to secure a tenant's performance of a lease agreement,
perhaps the closest analogy to the present situation. Pp. 493 U. S.
207 -214.

															857 F.2d 1162 (C.A.7 1988), affirmed.

															BLACKMUN, J., delivered the opinion for a unanimous Court. Page 493 U. S. 204 Justice BLACKMUN delivered the opinion of the Court.

															Respondent Indianapolis Power & Light Company (IPL) requires
certain customers to make deposits with it to assure payment of
future bills for electric service. Petitioner Commissioner of
Internal Revenue contends that these deposits are advance payments
for electricity, and therefore constitute taxable income to IPL
upon receipt. IPL contends otherwise. I IPL is a regulated Indiana corporation that generates and sells
electricity in Indianapolis and its environs. It keeps its books on
the accrual and calendar year basis. During the years 1974 through
1977, approximately 5% of IPL's residential and commercial
customers were required to make deposits "to insure prompt
payment," as the customers' receipts stated, of future utility
bills. These customers were selected because their credit was
suspect. Prior to March 10, 1976, the deposit requirement was
imposed on a case-by-case basis. IPL relied on a credit test but
employed no fixed formula. The amount of the required deposit
ordinarily was twice the customer's estimated monthly bill. IPL
paid 3% interest on a deposit held for six months or more. A
customer could obtain a refund of the deposit prior to termination
of service by requesting a review and demonstrating acceptable
credit. The refund usually was made in cash or by check, but the
customer Page 493 U. S. 205 could choose to have the amount applied against future
bills.

															In March, 1976, IPL amended its rules governing the deposit
program. See Title 170, Ind.Admin.Code 4-1-15 (1988).
Under the amended rules, the residential customers from whom
deposits were required were selected on the basis of a fixed
formula. The interest rate was raised to 6%, but was payable only
on deposits held for 12 months or more. A deposit was refunded when
the customer made timely payments for either nine consecutive
months or for 10 out of 12 consecutive months, so long as the two
delinquent months were not themselves consecutive. A customer could
obtain a refund prior to that time by satisfying the credit test.
As under the previous rules, the refund would be made in cash or by
check, or, at the customer's option, applied against future bills.
Any deposit unclaimed after seven years was to escheat to the
State. See Ind.Code § 32-9-1-6(a) (1988). [ Footnote 1 ]

															IPL did not treat these deposits as income at the time of
receipt. Rather, as required by state administrative regulations,
the deposits were carried on its books as current liabilities.
Under its accounting system, IPL recognized income when it mailed a
monthly bill. If the deposit was used to offset a customer's bill,
the utility made the necessary accounting adjustments. Customer
deposits were not physically segregated in any way from the
company's general funds. They were commingled with other receipts
and at all times were subject to IPL's unfettered use and control.
It is undisputed that IPL's treatment of the deposits was
consistent with accepted accounting practice and applicable state
regulations.

															Upon audit of respondent's returns for the calendar years 1974
through 1977, the Commissioner asserted deficiencies. Although
other items initially were in dispute, the parties were able to
reach agreement on every issue except that of Page 493 U. S. 206 the proper treatment of customer deposits for the years 1975,
1976, and 1977. The Commissioner took the position that the
deposits were advance payments for electricity, and therefore were
taxable to IPL in the year of receipt. He contended that the
increase or decrease in customer deposits outstanding at the end of
each year represented an increase or decrease in IPL's income for
the year. [ Footnote 2 ] IPL
disagreed and filed a petition in the United States Tax Court for
redetermination of the asserted deficiencies.

															In a reviewed decision, with one judge not participating, a
unanimous Tax Court ruled in favor of IPL. 88 T.C. 964 (1987). The
court followed the approach it had adopted in City Gas Co. of
Florida v. Commissioner of Internal Revenue, 74 T.C. 386
(1980), rev'd, 689 F.2d 943 (CA 11 1982). It found it
necessary to "continue to examine all of the circumstances," 88
T.C., at 976, and relied on several factors in concluding that the
deposits in question were properly excluded from gross income. It
noted, among other things, that only 5% of IPL's customers were
required to make deposits; that the customer, rather than the
utility, controlled the ultimate disposition of a deposit; and that
IPL consistently treated the deposits as belonging to the
customers, both by listing them as current liabilities for
accounting purposes and by paying interest. Id. at
976-978.

															The United States Court of Appeals for the Seventh Circuit
affirmed the Tax Court's decision. 857 F.2d 1162 (1988). The court
stated that

															"the proper approach to determining the appropriate tax
treatment of a customer deposit is to look at the primary purpose
of the deposit based on all the Page 493 U. S. 207 facts and circumstances. . . ." Id. at 1167. The court appeared to place primary
reliance, however, on IPL's obligation to pay interest on the
deposits. It asserted that

															"as the interest rate paid on a deposit to secure income begins
to approximate the return that the recipient would be expected to
make from 'the use' of the deposit amount, the deposit begins to
serve purposes that comport more squarely with a security
deposit." Id. at 1169. Noting that IPL had paid interest on the
customer deposits throughout the period in question, the court
upheld, as not clearly erroneous, the Tax Court's determination
that the principal purpose of these deposits was to serve as
security, rather than as prepayment of income. Id. at
1170.

															Because the Seventh Circuit was in specific disagreement with
the Eleventh Circuit's ruling in City Gas Co. of Florida,
supra, we granted certiorari to resolve the conflict. 490 U.S.
1033 (1989). II We begin with the common ground. IPL acknowledges that these
customer deposits are taxable as income upon receipt if they
constitute advance payments for electricity to be supplied.
[ Footnote 3 ] The Commissioner,
on his part, concedes that customer deposits.that secure the
performance of non-income-producing covenants -- such as a utility
customer's obligation to ensure that meters will not be damaged --
are not taxable income. And it is settled that receipt of a loan is
not income to the borrower. See Commissioner v. Tufts, 461 U. S. 300 , 461 U. S. 307 (1983) ("Because of [the repayment] obligation, Page 493 U. S. 208 the loan proceeds do not qualify as income to the taxpayer"); James v. United States, 366 U. S. 213 , 366 U. S. 219 (1961) (accepted definition of gross income "excludes loans"); Commissioner v. Wilcox, 327 U. S. 404 , 327 U. S. 408 (1946). IPL, stressing its obligation to refund the deposits with
interest, asserts that the payments are similar to loans. The
Commissioner, however, contends that a deposit which serves to
secure the payment of future income is properly analogized to an
advance payment for goods or services. See Rev.Rul.
72-519, 1972-2 Cum.Bull. 32, 33 ("[W]hen the purpose of the deposit
is to guarantee the customer's payment of amounts owed to the
creditor, such a deposit is treated as an advance payment, but when
the purpose of the deposit is to secure a property interest of the
taxpayer the deposit is regarded as a true security deposit").

															In economic terms, to be sure, the distinction between a loan
and an advance payment is one of degree rather than of kind. A
commercial loan, like an advance payment, confers an economic
benefit on the recipient: a business presumably does not borrow
money unless it believes that the income it can earn from its use
of the borrowed funds will be greater than its interest obligation. See Illinois Power Co. v. Commissioner of Internal
Revenue, 792 F.2d 683, 690 (CA7 1986). Even though receipt of
the money is subject to a duty to repay, the borrower must regard
itself as better off after the loan than it was before. The
economic benefit of a loan, however, consists entirely of the
opportunity to earn income on the use of the money prior to the
time the loan must be repaid. And in that context, our system is
content to tax these earnings as they are realized. The recipient
of an advance payment, in contrast, gains both immediate use of the
money (with the chance to realize earnings thereon) and the opportunity to make a profit by providing goods or services at
a cost lower than the amount of the payment.

															The question, therefore, cannot be resolved simply by noting
that respondent derives some economic benefit from receipt Page 493 U. S. 209 of these deposits. [ Footnote
4 ] Rather, the issue turns upon the nature of the rights and
obligations that IPL assumed when the deposits were made. In
determining what sort of economic benefits qualify as income, this
Court has invoked various formulations. It has referred, for
example, to "undeniable accessions to wealth, clearly realized, and
over which the taxpayers have complete dominion." Commissioner
v. Glenshaw Glass Co., 348 U. S. 426 , 348 U. S. 431 (1955). It also has stated:

															"When a taxpayer acquires earnings, lawfully or unlawfully,
without the consensual recognition, express or implied, of an
obligation to repay and without restriction as to their
disposition, 'he has received income. . . .'" James v. United States, 366 U.S. at 366 U. S. 219 ,
quoting North American Oil Consolidated v. Burnet, 286 U. S. 417 , 286 U. S. 424 (1932). IPL hardly enjoyed "complete dominion" over the customer
deposits entrusted to it. Rather, these deposits were acquired
subject to an express "obligation to repay," either at the time
service was terminated or at the time a customer established good
credit. So long as the customer fulfills his legal obligation to
make timely payments, his deposit ultimately is to be refunded, and
both the timing and method of that refund are largely within the
control of the customer.

															The Commissioner stresses the fact that these deposits were not
placed in escrow or segregated from IPL's other funds, and that IPL
therefore enjoyed unrestricted use of the money. That circumstance,
however, cannot be dispositive. After all, the same might be said
of a commercial loan; yet the Commissioner does not suggest that a
loan is taxable upon receipt simply because the borrower is free to
use the Page 493 U. S. 210 funds in whatever fashion he chooses until the time of
repayment. In determining whether a taxpayer enjoys "complete
dominion" over a given sum, the crucial point is not whether his
use of the funds is unconstrained during some interim period. The
key is whether the taxpayer has some guarantee that he will be
allowed to keep the money. IPL's receipt of these deposits was
accompanied by no such guarantee.

															Nor is it especially significant that these deposits could be
expected to generate income greater than the modest interest IPL
was required to pay. Again, the same could be said of a commercial
loan, since, as has been noted, a business is unlikely to borrow
unless it believes that it can realize benefits that exceed the
cost of servicing the debt. A bank could hardly operate profitably
if its earnings on deposits did not surpass its interest
obligations; but the deposits themselves are not treated as income.
[ Footnote 5 ] Any income that
the utility may earn through use of the deposit money of course is
taxable, but the prospect that income will be generated provides no
ground for taxing the principal.

															The Commissioner's advance payment analogy seems to us to rest
upon a misconception of the value of an advance payment to its
recipient. An advance payment, like the deposits at issue here,
concededly protects the seller against the risk that it would be
unable to collect money owed it after it has furnished goods or
services. But an advance payment does much more: it protects
against the risk that the purchaser will back out of the deal
before the seller performs. From the moment an advance payment is
made, the seller is assured that, so long as it fulfills its
contractual obligation, the money is its to keep. Here, in
contrast, a customer submitting a deposit made no commitment to
purchase a specified quantity of electricity, or indeed to purchase
any electricity Page 493 U. S. 211 at all. [ Footnote 6 ] IPL's
right to keep the money depends upon the customer's purchase of
electricity, and upon his later decision to have the deposit
applied to future bills, not merely upon the utility's adherence to
its contractual duties. Under these circumstances, IPL's dominion
over the fund is far less complete than is ordinarily the case in
an advance-payment situation.

															The Commissioner emphasizes that these deposits frequently will
be used to pay for electricity, either because the customer
defaults on his obligation or because the customer, having
established credit, chooses to apply the deposit to future bills
rather than to accept a refund. When this occurs, the Commissioner
argues, the transaction, from a cash-flow standpoint, is equivalent
to an advance payment. In his view this economic equivalence
mandates identical tax treatment. [ Footnote 7 ]

															Whether these payments constitute income when received, however,
depends upon the parties' rights and obligations at the time
the payments are made. The problem with petitioner's argument
perhaps can best be understood if we imagine a loan between parties
involved in an ongoing commercial Page 493 U. S. 212 relationship. At the time the loan falls due, the lender may
decide to apply the money owed him to the purchase of goods or
services, rather than to accept repayment in cash. But this
decision does not mean that the loan, when made, was an advance
payment after all. The lender in effect has taken repayment of his
money (as was his contractual right) and has chosen to use the
proceeds for the purchase of goods or services from the borrower.
Although, for the sake of convenience, the parties may combine the
two steps, that decision does not blind us to the fact that in
substance two transactions are involved. [ Footnote 8 ]

															It is this element of choice that distinguishes an advance
payment from a loan. Whether these customer deposits are the
economic equivalents of advance payments, and therefore taxable
upon receipt, must be determined by examining the relationship
between the parties at the time of the deposit. The individual who
makes an advance payment retains no right to insist upon the return
of the funds; so long as the recipient fulfills the terms of the
bargain, the money is its to keep. The customer who submits a
deposit to the utility, like the lender in the previous
hypothetical, retains the right to insist upon repayment in cash;
he may choose to apply the money to the purchase of electricity,
but he assumes no obligation to do so, and the utility therefore
acquires no unfettered "dominion" over the money at the time of
receipt.

															When the Commissioner examines privately structured
transactions, the true understanding of the parties, of course, may
not be apparent. It may be that a transfer of funds, though
nominally a loan, may conceal an unstated agreement that the money
is to be applied to the purchase of goods or Page 493 U. S. 213 services. We need not, and do not, attempt to devise a test for
addressing those situations where the nature of the parties'
bargain is legitimately in dispute. This particular respondent,
however, conducts its business in a heavily regulated environment;
its rights and obligations vis-a-vis its customers are largely
determined by law and regulation, rather than by private
negotiation. That the utility's customers, when they qualify for
refunds of deposits, frequently choose to apply those refunds to
future bills rather than taking repayment in cash does not mean
that any customer has made an unspoken commitment to do so.

															Our decision is also consistent with the Tax Court's
long-standing treatment of lease deposits -- perhaps the closest
analogy to the present situation. The Tax Court traditionally has
distinguished between a sum designated as a prepayment of rent --
which is taxable upon receipt -- and a sum deposited to secure the
tenant's performance of a lease agreement. See, e.g., J. &
E. Enterprises, Inc. v. Commissioner, 26 TCM 944 (1967).
[ Footnote 9 ] In fact, the
customer deposits Page 493 U. S. 214 at issue here are less plausibly regarded as income than lease
deposits would be. The typical lease deposit secures the tenant's
fulfillment of a contractual obligation to pay a specified rent
throughout the term of the lease. The utility customer, however,
makes no commitment to purchase any services at all at the time he
tenders the deposit.

															We recognize that IPL derives an economic benefit from these
deposits. But a taxpayer does not realize taxable income from every
event that improves his economic condition. A customer who makes
this deposit reflects no commitment to purchase services, and IPL's
right to retain the money is contingent upon events outside its
control. We hold that such dominion as IPL has over these customer
deposits is insufficient for the deposits to qualify as taxable
income at the time they are made.

															The judgment of the Court of Appeals is affirmed. It is so ordered. [ Footnote 1 ]

															During the years 1974 through 1977, the total amount that
escheated to the State was less than $9,325. Stipulation of Facts �
25.

															[ Footnote 2 ]

															The parties' stipulation sets forth the balance in IPL's
customer-deposit account on December 31 of each of the years 1954,
1974, 1975, 1976, and 1977. In his notice of deficiency, the
Commissioner concluded that IPL was required to include in income
for 1975 the increase in the account between December 31, 1954, and
December 31, 1975. For 1976 and 1977, IPL was allowed to reflect in
income the respective decreases in the account during those
years.

															[ Footnote 3 ]

															This Court has held that an accrual-basis taxpayer is required
to treat advance payments as income in the year of receipt. See
Schlude v. Commissioner, 372 U. S. 128 (1963); American Automobile Assn. v. United States, 367 U. S. 687 (1961); Automobile Club of Michigan v. Commissioner, 353 U. S. 180 (1957). These cases concerned payments -- nonrefundable fees for
services -- that indisputably constituted income, the issue was
when that income was taxable. Here, in contrast, the issue is
whether these deposits, as such, are income at all.

															[ Footnote 4 ] See Illinois Power Co., 792 F.2d at 690. See
also Burke & Friel, Recent Developments in the Income
Taxation of Individuals, Tax-Free Security: Reflections on Indianapolis Power & Light, 12 Rev. of Taxation of
Individuals 157 174 (1988) (arguing that economic-benefit approach
is superior in theory, but acknowledging that "an economic-benefit
test has not been adopted, and it is unlikely that such an approach
will be pursued by the Service or the courts").

															[ Footnote 5 ] Cf. Rev.Rul. 71-189, 1971-1 Cum.Bull. 32 (inactive
deposits are not income until bank asserts dominion over the
accounts). See also Fidelity-Philadelphia Trust Co. v.
Commissioner, 23 T.C. 527 (1954).

															[ Footnote 6 ]

															A customer, for example, might terminate service the day after
making the deposit. Also, IPL's dominion over a deposit remains
incomplete even after the customer begins buying electricity. As
has been noted, the deposit typically is set at twice the
customer's estimated monthly bill. So long as the customer pays his
bills in a timely fashion, the money he owes the utility (for
electricity used but not yet paid for) almost always will be less
than the amount of the deposit. If this were not the case, the
deposit would provide inadequate protection. Thus, throughout the
period the deposit is held, at least a portion is likely to be
money that IPL has no real assurance of ever retaining.

															[ Footnote 7 ]

															The Commissioner is unwilling, however, to pursue this line of
reasoning to the limit of its logic. He concedes that these
deposits would not be taxable if they were placed in escrow, Tr. of
Oral Arg. 4; but, from a cash-flow standpoint, it does not make
much difference whether the money is placed in escrow or commingled
with the utility's other funds. In either case, the utility
receives the money and allocates it to subsequent purchases of
electricity if the customer defaults or chooses to apply his refund
to a future bill.

															[ Footnote 8 ]

															The Commissioner contends that a customer's decision to take his
refund while making a separate payment for services, rather than
applying the deposit to his bill, would amount to nothing more than
an economically meaningless "exchange of checks." But in our view,
the "exchange of checks," while less convenient, more accurately
reflects the economic substance of the transactions.

															[ Footnote 9 ]

															In J. & E. Enterprises, the Tax Court stated:

															"If a sum is received by a lessor at the beginning of a lease,
is subject to his unfettered control, and is to be applied as rent
for a subsequent period during the term of the lease, such sum is
income in the year of receipt even though in certain circumstances
a refund thereof may be required. . . . If, on the other hand, a
sum is deposited to secure the lessee's performance under a lease,
and is to be returned at the expiration thereof, it is not taxable
income even though the fund is deposited with the lessor instead of
in escrow and the lessor has temporary use of the money. . . . In
this situation, the acknowledged liability of the lessor to account
for the deposited sum on the lessee's performance of the lease
covenants prevents the sum from being taxable in the year of
receipt."

															26 TCM at 945-946.

															In Rev.Rul. 72-519, 1972-2 Cum.Bull. 32, the Commissioner relied
in part on J. & E. Enterprises as authority for the
proposition that deposits intended to secure income-producing
covenants are advance payments taxable as income upon receipt,
while deposits intended to secure non-income-producing covenants
are not. Id. at 33. In our view, neither J. & E
Enterprises nor the other cases cited in the Revenue Ruling
support that distinction. See Hirsch Improvement Co. v.
Commissioner of Internal Revenue, 143 F.2d 912 (CA2), cert. denied, 323 U.S. 750 (1944); Mantell v.
Commissioner, 17 T.C. 1143 ( 1952); Gilken Corp. v.
Commissioner, 10 T.C. 445 (1948), aff'd, 176 F.2d 141
(CA 6 1949). These cases all distinguish between advance payments
and security deposits, not between deposits that do and do not
secure income-producing covenants.

Summary: The Supreme Court ruled that customer deposits made to a utility company to assure payment of future bills are not considered advance payments for electricity and, therefore, are not taxable income for the company upon receipt. While the company has temporary use of the money and derives some economic benefit, it does not have complete dominion over the deposits, as customers can obtain a refund or choose to apply the deposit to future bills. The Court's decision is consistent with the longstanding treatment of security deposits in other contexts, such as lease agreements.


U.S. Supreme Court Arkansas Best Corp. v. Commissioner, 485
U.S. 212 (1988) Arkansas Best Corp. v. Commissioner
of Internal Revenue No. 86-751 Argued December 9,
1987 Decided March 7, 1988 485
U.S. 212 CERTIORARI TO THE UNITED STATES
COURT OF APPEALS FOR THE EIGHTH CIRCUIT Syllabus Under § 1221 of the Internal Revenue Code, the term "capital
asset" means "property held by the taxpayer (whether or not
connected with his trade or business), but does not include" five
specified classes of property. Between 1968 and 1974, petitioner, a
diversified holding company, acquired approximately 65% of a bank's
stock. The bank was apparently prosperous until 1972, when federal
examiners classified it as a problem bank. In 1975, petitioner sold
the bulk of the stock at a loss, which it claimed as an ordinary
loss deduction on its federal income tax return for that year. The
Commissioner of Internal Revenue disallowed the deduction, finding
that the loss was a capital loss rather than an ordinary loss. The
Tax Court, relying on cases interpreting Corn Products Refining
Co. v. Commissioner, 350 U. S. 46 , held
that, since the stock acquired through 1972 was purchased with a
substantial investment purpose, it was a capital asset under § 1221
and therefore gave rise to a capital loss when it was sold;
however, the loss realized on the stock acquired after 1972 was
subject to ordinary loss treatment, since that stock had been
bought and held exclusively for the business purpose of protecting
petitioner's reputation by fending off the bank's failure. The
Court of Appeals reversed the latter determination, ruling that all
of the stock sold in 1975 was subject to capital loss
treatment. Held: A taxpayer's motivation in purchasing an asset is
irrelevant to the question whether it falls within the broad
definition of "capital asset" in § 1221. Petitioner's reading of Corn Products as authorizing ordinary asset treatment for
any asset acquired and held for business, rather than investment,
purposes is too expansive. That reading finds no support in §
1221's language, which does not mention a business motive test, and
is in direct conflict with § 1221's broad definition of capital
asset. Similarly, the contention that § 1221's five listed
exceptions are merely illustrative, rather than exhaustive, is
refuted by the statute's "does not include" phrase, and by the
legislative history and the applicable Treasury regulation.
Moreover, petitioner's reading would make surplusage of three of
the statutory exceptions, whose excluded classes of property would
undoubtedly satisfy a business motive test. Corn Products must instead be interpreted as standing for the narrow proposition
that "hedging" Page 485 U. S. 213 transactions that are an integral part of a business' inventory
purchase system fall within § 1221's first exception for "property
. . . which would properly be included in the [taxpayer's]
inventory." Since petitioner, which is not a dealer in securities,
has never suggested that its bank stock falls within the inventory
exclusion, Corn Products has no application in the present
context. Because petitioner's bank stock falls within §1221's broad
definition of "capital asset" and is outside the classes of
excluded property, the loss arising from its sale is a capital
loss. Pp. 485 U. S.
216 -223.

															800 F.2d 215, affirmed.

															MARSHALL, J., delivered the opinion of the Court, in which all
other Members joined, except KENNEDY, J., who took no part in the
consideration or decision of the case.

															JUSTICE MARSHALL delivered the opinion of the Court.

															The issue presented in this case is whether capital stock held
by petitioner Arkansas Best Corporation (Arkansas Best) is a
"capital asset" as defined in § 1221 of the Internal Revenue Code
regardless of whether the stock was purchased and held for a
business purpose or for an investment purpose. I Arkansas Best is a diversified holding company. In 1968, it
acquired approximately 65% of the stock of the National Page 485 U. S. 214 Bank of Commerce (Bank) in Dallas, Texas. Between 1969 and 1974,
Arkansas Best more than tripled the number of shares it owned in
the Bank, although its percentage interest in the Bank remained
relatively stable. These acquisitions were prompted principally by
the Bank's need for added capital. Until 1972, the Bank appeared to
be prosperous and growing, and the added capital was necessary to
accommodate this growth. As the Dallas real estate market declined,
however, so too did the financial health of the Bank, which had a
heavy concentration of loans in the local real estate industry. In
1972, federal examiners classified the Bank as a problem bank. The
infusion of capital after 1972 was prompted by the loan portfolio
problems of the bank.

															Petitioner sold the bulk of its Bank stock on June 30, 1975,
leaving it with only a 14.7% stake in the Bank. On its federal
income tax return for 1975, petitioner claimed a deduction for an
ordinary loss of $9,995,688 resulting from the sale of the stock.
The Commissioner of Internal Revenue disallowed the deduction,
finding that the loss from the sale of stock was a capital loss,
rather than an ordinary loss, and that it therefore was subject to
the capital loss limitations in the Internal Revenue Code.
[ Footnote 1 ]

															Arkansas Best challenged the Commissioner's determination in the
United States Tax Court. The Tax Court, relying on cases
interpreting Corn Products Refining Co. v. Commissioner, 350 U. S. 46 (1955), held that stock purchased with a substantial investment
purpose is a capital asset which, when sold, gives rise to a
capital gain or loss, whereas stock purchased and held for a
business purpose, without any substantial investment motive, is an
ordinary asset whose sale gives rise to ordinary gains or losses. See 83 T.C. 640, Page 485 U. S. 215 653-654 (1984). The court characterized Arkansas Best's
acquisitions through 1972 as occurring during the Bank's
" growth' phase," and found that these acquisitions "were
motivated primarily by investment purpose, and only incidentally by
some business purpose." Id. at 654. The stock acquired
during this period therefore constituted a capital asset, which
gave rise to a capital loss when sold in 1975. The court
determined, however, that the acquisitions after 1972 occurred
during the Bank's "`problem' phase," ibid., and, except
for certain minor exceptions, "were made exclusively for business
purposes and subsequently held for the same reasons." Id. at 656. These acquisitions, the court found, were designed to
preserve petitioner's business reputation, because without the
added capital the Bank probably would have failed. Id. at
656-657. The loss realized on the sale of this stock was thus held
to be an ordinary loss. The Court of Appeals for the Eighth Circuit reversed the Tax
Court's determination that the loss realized on stock purchased
after 1972 was subject to ordinary loss treatment, holding that all
of the Bank stock sold in 1975 was subject to capital loss
treatment. 800 F.2d 215 (1986). The court reasoned that the Bank
stock clearly fell within the general definition of "capital asset"
in Internal Revenue Code § 1221, and that the stock did not fall
within any of the specific statutory exceptions to this definition.
The court concluded that Arkansas Best's purpose in acquiring and
holding the stock was irrelevant to the determination whether the
stock was a capital asset. We granted certiorari, 480 U.S. 930, and
now affirm. II Section 1221 of the Internal Revenue Code defines "capital
asset" broadly as "property held by the taxpayer (whether or not
connected with his trade or business)," and then excludes five
specific classes of property from capital asset Page 485 U. S. 216 status. In the statute's present form, [ Footnote 2 ] the classes of property exempted from the
broad definition are (1) "property of a kind which would properly
be included in the inventory of the taxpayer"; (2) real property or
other depreciable property used in the taxpayer's trade or
business; (3) "a copyright, a literary, musical, or artistic
composition," or similar property; (4) "accounts or notes
receivable acquired in the ordinary course of trade or business for
services rendered" or from the sale of inventory; and (5)
publications of the Federal Government. Arkansas Best acknowledges
that the Bank stock falls within the literal definition of "capital
asset" in § 1221, and is outside of the statutory exclusions. It
asserts, however, that this determination does not end the inquiry.
Petitioner argues that, in Corn Products Refining Co. v.
Commissioner, supra, this Court rejected a literal reading of
§ 1221, and concluded that assets acquired and sold for ordinary
business purposes, rather than for investment purposes, should be
given ordinary asset treatment. Petitioner's reading of Corn
Products finds much support in the academic literature
[ Footnote 3 ] and in the courts.
[ Footnote 4 ] Unfortunately for
petitioner, this broad reading finds no support in the language of
§ 1221. Page 485 U. S. 217 In essence, petitioner argues that "property held by the
taxpayer (whether or not connected with his trade or business)"
does not include property that is acquired and held for a business
purpose. In petitioner's view, an asset's status as "property" thus
turns on the motivation behind its acquisition. This motive test,
however, is not only nowhere mentioned in § 1221, but it is also in
direct conflict with the parenthetical phrase "whether or not
connected with his trade or business." The broad definition of the
term "capital asset" explicitly makes irrelevant any consideration
of the property's connection with the taxpayer's business, whereas
petitioner's rule would make this factor dispositive. [ Footnote 5 ]

															In a related argument, petitioner contends that the five
exceptions listed in § 1221 for certain kinds of property are
illustrative, rather than exhaustive, and that courts are therefore
free to fashion additional exceptions in order to further the
general purposes of the capital asset provisions. The language of
the statute refutes petitioner's construction. Section 1221
provides that "capital asset" means "property held by the
taxpayer[,] . . . but does not include" the five classes Page 485 U. S. 218 of property listed as exceptions. We believe this locution
signifies that the listed exceptions are exclusive. The body of §
1221 establishes a general definition of the term "capital asset,"
and the phrase "does not include" takes out of that broad
definition only the classes of property that are specifically
mentioned. The legislative history of the capital asset definition
supports this interpretation, see H.R.Rep. No. 704, 73d
Cong., 2d Sess., 31 (1934) ("[T]he definition includes all
property, except as specifically excluded"); H.R.Rep. No. 1337, 83d
Cong., 2d Sess., A273 (1954) ("[A] capital asset is property held
by the taxpayer with certain exceptions"), as does the applicable
Treasury regulation, see 26 CFR § 1.1221-1(a) (1987) ("The
term capital assets' includes all classes of property not
specifically excluded by section 1221"). Petitioner's reading of the statute is also in tension with the
exceptions listed in § 1221. These exclusions would be largely
superfluous if assets acquired primarily or exclusively for
business purposes were not capital assets. Inventory, real or
depreciable property used in the taxpayer's trade or business, and
accounts or notes receivable acquired in the ordinary course of
business would undoubtedly satisfy such a business motive test. Yet
these exceptions were created by Congress in separate enactments
spanning 30 years. [ Footnote 6 ]
Without any express direction from Congress, we are unwilling to
read § 1221 in a manner that makes surplusage of these statutory
exclusions. Page 485 U. S. 219 In the end, petitioner places all reliance on its reading of Corn Products Refining Co. v. Commissioner, 350 U. S.
46 (1965) -- a reading we believe is too expansive. In Corn Products, the Court considered whether income arising
from a taxpayer's dealings in corn futures was entitled to capital
gains treatment. The taxpayer was a company that converted corn
into starches, sugars, and other products. After droughts in the
1930's caused sharp increases in corn prices, the company began a
program of buying corn futures to assure itself an adequate supply
of corn and protect against price increases. See id. at 350 U. S. 48 .
The company

															"would take delivery on such contracts as it found necessary to
its manufacturing operations and sell the remainder in early summer
if no shortage was imminent. If shortages appeared, however, it
sold futures only as it bought spot corn for grinding." Id. at 350 U. S. 48 -49.
The Court characterized the company's dealing in corn futures as
"hedging." Id. at 350 U. S. 51 . As explained by the Court of Appeals in Corn Products, "[h]edging is a method of dealing in commodity futures whereby a
person or business protects itself against price fluctuations at
the time of delivery of the product which it sells or buys."

															215 F.2d 513, 515 (CA2 1954). In evaluating the company's claim
that the sales of corn futures resulted in capital gains and
losses, this Court stated:

															"Nor can we find support for petitioner's contention that
hedging is not within the exclusions of [§ 1221]. Admittedly,
petitioner's corn futures do not come within the literal language
of the exclusions set out in that section. They were not stock in
trade, actual inventory, property held for sale to customers or
depreciable property used in a trade or business. But the capital
asset provision of [§ 1221] must not be so broadly applied as to
defeat, rather than further, the purpose of Congress. Congress
intended that profits and losses arising from the everyday
operation of a business be considered as ordinary income or loss,
rather than capital gain or loss. . . . " Page 485 U. S. 220 Since this section is an exception from the normal tax
requirements of the Internal Revenue Code, the definition of a
capital asset must be narrowly applied, and its exclusions
interpreted broadly.

															350 U.S. at 350 U. S. 51 -52
(citations omitted). The Court went on to note that hedging
transactions consistently had been considered to give rise to
ordinary gains and losses, and then concluded that the corn futures
were subject to ordinary asset treatment. Id. at 350 U. S.
52 -53.

															The Court in Corn Products proffered the oft-quoted
rule of construction that the definition of "capital asset" must be
narrowly applied, and its exclusions interpreted broadly, but it
did not state explicitly whether the holding was based on a narrow
reading of the phrase "property held by the taxpayer" or on a broad
reading of the inventory exclusion of § 1221. In light of the stark
language of § 1221, however, we believe that Corn Products is properly interpreted as involving an application of § 1221's
inventory exception. Such a reading is consistent both with the
Court's reasoning in that case and with § 1221. The Court stated in Corn Products that the company's futures transactions
were

															"an integral part of its business designed to protect its
manufacturing operations against a price increase in its principal
raw material and to assure a ready supply for future manufacturing
requirements."

															350 U.S. at 350 U. S. 50 .
The company bought, sold, and took delivery under the futures
contracts as required by the company's manufacturing needs. As
Professor Bittker notes, under these circumstances, the futures can
"easily be viewed as surrogates for the raw material itself." 2 B.
Bittker, Federal Taxation of Income, Estates and Gifts � 51.10.3,
p. 51-62 (1981). The Court of Appeals for the Second Circuit, in Corn Products, clearly took this approach. That court
stated that, when commodity futures are "utilized solely for the
purpose of stabilizing inventory cost[,] . . . [they] cannot
reasonably be separated from the inventory items," and concluded
that "property used in hedging transactions Page 485 U. S. 221 properly comes within the exclusions of [§ 1221]." 215 F.2d at
516. This Court indicated its acceptance of the Second Circuit's
reasoning when it began the central paragraph of its opinion: "Nor
can we find support for petitioner's contention that hedging is not
within the exclusions of [§ 1221]." 350 U.S. at 350 U. S. 51 . In
the following paragraph, the Court argued that the Treasury had
consistently viewed such hedging transactions as a form of
insurance to stabilize the cost of inventory, and cited a Treasury
ruling which concluded that the value of a manufacturer's raw
material inventory should be adjusted to take into account hedging
transactions in futures contracts. See id. at 350 U. S. 52 -53
(citing G.C.M. 17322, XV-2 Cum. Bull. 151 (1936)). This discussion,
read in light of the Second Circuit's holding and the plain
language of § 1221, convinces us that, although the corn futures
were not "actual inventory," their use as an integral part of the
taxpayer's inventory purchase system led the Court to treat them as
substitutes for the corn inventory such that they came within a
broad reading of "property of a kind which would properly be
included in the inventory of the taxpayer" in § 1221.

															Petitioner argues that, by focusing attention on whether the
asset was acquired and sold as an integral part of the taxpayer's
everyday business operations, the Court in Corn Products intended to create a general exemption from capital asset status
for assets acquired for business purposes. We believe petitioner
misunderstands the relevance of the Court's inquiry. A business
connection, although irrelevant to the initial determination
whether an item is a capital asset, is relevant in determining the
applicability of certain of the statutory exceptions, including the
inventory exception. The close connection between the futures
transactions and the taxpayer's business in Corn Products was crucial to whether the corn futures could be considered
surrogates for the stored inventory of raw corn. For if the futures
dealings were not part of the company's inventory purchase
system, Page 485 U. S. 222 and instead amounted simply to speculation in corn futures, they
could not be considered substitutes for the company's corn
inventory, and would fall outside even a broad reading of the
inventory exclusion. We conclude that Corn Products is
properly interpreted as standing for the narrow proposition that
hedging transactions that are an integral part of a business'
inventory purchase system fall within the inventory exclusion of §
1221. [ Footnote 7 ] Arkansas
Best, which is not a dealer in securities, has never suggested that
the Bank stock falls within the inventory exclusion. Corn
Products thus has no application to this case.

															It is also important to note that the business motive test
advocated by petitioner is subject to the same kind of abuse that
the Court condemned in Corn Products. The Court explained
in Corn Products that, unless hedging transactions were
subject to ordinary gain and loss treatment, taxpayers engaged in
such transactions could "transmute ordinary income into capital
gain at will." 350 U.S. at 350 U. S. 53 -54. The hedger could garner capital asset
treatment by selling the future and purchasing the commodity on the
spot market, or ordinary asset treatment by taking delivery under
the future contract. In a similar vein, if capital stock purchased
and held for a business purpose is an ordinary asset, whereas the
same stock purchased and held with an investment motive is a
capital asset, a taxpayer such as Arkansas Best could have
significant influence over whether the asset would receive capital
or ordinary treatment. Because stock is most naturally Page 485 U. S. 223 v..iewed as a capital asset, the Internal Revenue Service would
be hard-pressed to challenge a taxpayer's claim that stock was
acquired as an investment, and that a gain arising from the sale of
such stock was therefore a capital gain. Indeed, we are unaware of
a single decision that has applied the business motive test so as
to require a taxpayer to report a gain from the sale of stock as an
ordinary gain. If the same stock is sold at a loss, however, the
taxpayer may be able to garner ordinary loss treatment by
emphasizing the business purpose behind the stock's acquisition.
The potential for such abuse was evidenced in this case by the fact
that, as late as 1974, when Arkansas Best still hoped to sell the
Bank stock at a profit, Arkansas Best apparently expected to report
the gain as a capital gain. See 83 T.C. at 647-648. III We conclude that a taxpayer's motivation in purchasing an asset
is irrelevant to the question whether the asset is "property held
by a taxpayer (whether or not connected with his business)" and is
thus within § 1221's general definition of "capital asset." Because
the capital stock held by petitioner falls within the broad
definition of the term "capital asset" in § 1221 and is outside the
classes of property excluded from capital asset status, the loss
arising from the sale of the stock is a capital loss. Corn
Products Refining Co. v. Commissioner, supra, which we
interpret as involving a broad reading of the inventory exclusion
of § 1221, has no application in the present context. Accordingly,
the judgment of the Court of Appeals is affirmed. It is so ordered. JUSTICE KENNEDY took no part in the consideration or decision of
this case.

															[ Footnote 1 ]

															Title 26 U.S.C. § 1211(a) states that

															"[i]n the case of a corporation, losses from sales or exchanges
of capital assets shall be allowed only to the extent of gains from
such sales or exchanges."

															Section 1212(a) establishes rules governing carrybacks and
carryovers of capital losses, permitting such losses to offset
capital gains in certain earlier or later years.

															[ Footnote 2 ]

															In 1975, when petitioner sold its Bank stock, § 1221 contained a
different exception (5), which excluded certain federal and state
debt obligations. See 26 U.S.C. § 1221(5) (1970 ed.). That
exception was repealed by the Economic Recovery Tax Act of 1981,
Pub.L. 97-34, § 505(a), 95 Stat. 331. The present exception (5) was
added by the Tax Reform Act of 1976, Pub.L. 94-455, § 2132(a), 90
Stat.1925. These changes have no bearing on this case.

															[ Footnote 3 ] See, e.g., 2 B. Bittker, Federal Taxation of Income,
Estates and Gifts § 151.10.3, p. 51-62 (1981); Chirelstein, Capital
Gain and the Sale of a Business Opportunity: The Income Tax
Treatment of Contract Termination Payments, 49 Minn.L.Rev. 1, 41
(1964); Troxell & Noall, Judicial Erosion of the Concept of
Securities as Capital Assets, 19 Tax L.Rev. 185, 187 (1964); Note,
The Corn Products Doctrine and Its Application to
Partnership Interests, 79 Colum.L.Rev. 341, and n. 3 (1979).

															[ Footnote 4 ] See, e.g., Campbell Taggart, Inc. v. United States, 744
F.2d 442, 456-458 (CA5 1984); Steadman v. Commissioner, 424 F.2d 1, 5 (CA6), cert. denied, 400 U.S. 869 (1970); Booth Newspapers, Inc. v. United States, 157 Ct.Cl. 886,
893-896, 303 F.2d 916, 920-921 (1962); W. W. Windle Co. v.
Commissioner, 65 T.C. 694, 707-713 (1976).

															[ Footnote 5 ]

															Petitioner mistakenly relies on cases in which this Court, in
narrowly applying the general definition of "capital asset,"
has

															"construed 'capital asset' to exclude property representing
income items or accretions to the value of a capital asset
themselves properly attributable to income,"

															even though these items are property in the broad sense of the
word. United States v. Midland-Ross Corp., 381 U. S.
54 , 381 U. S. 57 (1965). See, e.g., Commissioner v. Gillette Motor Co., 364 U. S. 130 (1960) ("capital asset" does not include compensation awarded
taxpayer that represented fair rental value of its facilities); Commissioner v. P.G. Lake, Inc., 356 U.
S. 260 (1958) ("capital asset" does not include proceeds
from sale of oil payment rights); Hort v. Commissioner, 313 U. S. 28 (1941)
("capital asset" does not include payment to lessor for
cancellation of unexpired portion of a lease). This line of cases,
based on the premise that § 1221 "property" does not include claims
or rights to ordinary income, has no application in the present
context. Petitioner sold capital stock, not a claim to ordinary
income.

															[ Footnote 6 ]

															The inventory exception was part of the original enactment of
the capital asset provision in 1924. See Revenue Act of
1924, ch. 234, § 208(a)(8), 43 Stat. 263. Depreciable property used
in a trade or business was excluded in 1938, see Revenue
Act of 1938, ch. 289, § 117(a)(1), 52 Stat. 500, and real property
used in a trade or business was excluded in 1942, see Revenue Act of 1942, ch. 619, § 151(a), 56 Stat. 846. The exception
for accounts and notes receivable acquired in the ordinary course
of trade or business was added in 1954. Internal Revenue Code of
1954, § 1221(4), 68A Stat. 322.

															[ Footnote 7 ]

															Although congressional inaction is generally a poor measure of
congressional intent, we are given some pause by the fact that over
25 years have passed since Corn Products Refining Co. v.
Commissioner was initially interpreted as excluding assets
acquired for business purposes from the definition of "capital
asset," see Booth Newspapers, Inc. v. United States, 157
Ct.Cl. 886, 303 F.2d 916 (1962), without any sign of disfavor from
Congress. We cannot ignore the unambiguous language of § 1221,
however, no matter how reticent Congress has been. If a broad
exclusion from capital asset status is to be created for assets
acquired for business purposes, it must come from congressional
action, not silence.

Summary:
Here is a summary of the Supreme Court case, Arkansas Best Corp. v. Commissioner (1988):

Issue: Whether a taxpayer's motivation for purchasing an asset is relevant in determining if it qualifies as a "capital asset" under § 1221 of the Internal Revenue Code.

Holding: The Supreme Court held that a taxpayer's motivation for purchasing an asset is irrelevant in determining its status as a "capital asset." The Court interpreted the Corn Products case narrowly, stating that it applies only to "hedging" transactions integral to a business' inventory purchase system, which fall under the first exception of § 1221. The Court rejected the argument that the five listed exceptions in § 1221 are illustrative rather than exhaustive and emphasized the broad definition of "capital asset."

Facts: Arkansas Best Corp., a diversified holding company, acquired ~65% of a bank's stock between 1968 and 1974. After the bank encountered problems in 1972, Arkansas Best sold most of the stock at a loss in 1975. They claimed an ordinary loss deduction, but the Commissioner disallowed it, treating it as a capital loss. The Tax Court and Court of Appeals had conflicting rulings on the matter.

Reasoning: The Court found that § 1221's definition of "capital asset" does not include a business motive test and that the listed exceptions are exhaustive, refuting Arkansas Best's arguments. The Court also noted that interpreting Corn Products to allow ordinary asset treatment for business-related assets would conflict with § 1221's broad definition and render some statutory exceptions redundant.


OCTOBER TERM, 2000

															Syllabus

															GITLITZ ET AL. v. COMMISSIONER OF INTERNAL REVENUE

															CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE TENTH
CIRCUIT

															No. 99-1295. Argued October 2, 2000-Decided January 9, 2001

															Shareholders of a corporation taxed under Subchapter S of the
Internal Revenue Code may elect a "pass-through" taxation system,
under which the corporation's profits pass through directly to its
shareholders on a pro rata basis and are reported on the
shareholders' individual tax returns. 26 U. S. C. § 1366(a)(1)(A).
To prevent double taxation of distributed income, shareholders may
increase their corporate bases by certain items of income. §
1367(a)(1)(A). Corporate losses and deductions are passed through
in a similar manner, § 1366(a)(1)(A), and the shareholders' bases
in the S corporation's stock and debt are decreased accordingly, §§
1367(a)(2)(B), 1367(b)(2)(A). However, to the extent that such
losses and deductions exceed a shareholder's basis in the S
corporation's stock and debt, the excess is "suspended" until that
basis becomes large enough to permit the deduction. §§
1366(d)(1)-(2). In 1991, an insolvent S corporation in which
petitioners David Gitlitz and Philip Winn were shareholders
excluded its entire discharge of indebtedness amount from gross
income. On their tax returns, petitioners used their pro rata share
of the discharge amount to increase their bases in the
corporation's stock on the theory that it was an "item of income"
subject to pass-through. They used their increased bases to deduct
corporate losses and deductions, including suspended ones from
previous years. With the upward basis adjustments, they were each
able to deduct the full amount of their pro rata share of the
corporation's losses. The Commissioner determined that they could
not use the corporation's discharge of indebtedness to increase
their bases in the stock and denied their loss deductions. The Tax
Court ultimately agreed. In affirming, the Tenth Circuit assumed
that excluded discharge of indebtedness is an item of income
subject to pass-through, but held that the discharge amount first
had to be used to reduce certain tax attributes of the S
corporation under § 108(b) and that only the leftover amount could
be used to increase basis. Because the tax attribute to be reduced
here (the corporation's net operating loss) equaled the discharged
debt amount, that entire amount was absorbed by the reduction at
the corporate level and nothing remained to be passed through to
the shareholders. 207 Held:

															1. The statute's plain language establishes that excluded
discharged debt is an "item of income," which passes through to
shareholders and increases their bases in an S corporation's stock.
Section 61(a)(12) states that discharge of indebtedness is included
in gross income. And § 108(a) provides only that the discharge
ceases to be included in gross income when the S corporation is
insolvent, not that it ceases to be an item of income, as
the Commissioner contends. Not all items of income are included in
gross income, see § 1366(a)(I), so an item's mere exclusion from
gross income does not imply that the amount ceases to be an item of
income. Moreover, §§ 101 through 136 employ the same construction
to exclude various items from gross income, but not even the
Commissioner encourages a reading that would exempt all such items
from pass-through. Instead the Commissioner asserts that discharge
of indebtedness is unique because it requires no economic outlay on
the taxpayer's part, but can identify no statutory language that
makes this distinction relevant. On the contrary, the statute makes
clear that § 108(a)'s exclusion does not alter the character of
discharge of indebtedness as an item of income. Specifically, §
108(e) presumes that such discharge is always "income," and that
the only question for § 108 purposes is whether it is includible in
gross income. The Commissioner's contentions that, notwithstanding
the statute's plain language, excluded discharge of indebtedness is
not income and, specifically, that it is not "tax-exempt income"
under § 1366(a)(I)(A) do not alter the conclusion reached here. Pp.
212-216.

															2. Pass-through is performed before the reduction of an S
corporation's tax attributes under § 108(b). The sequencing
question presented here is important. If attribute reduction is
performed before the discharge of indebtedness is passed
through to the shareholders, the shareholders' losses that exceed
basis are treated as the corporation's net operating loss and are
then reduced by the amount of the discharged debt; in this case no
suspended losses would remain that would permit petitioners to take
deductions. However, if it is performed after the discharged
debt income is passed through, then the shareholders would be able
to deduct their losses (up to the amount of the increase in basis
caused by the discharged debt). Any suspended losses remaining then
will be treated as the S corporation's net operating loss and
reduced by the discharged debt amount. Section 108(b)(4)(A)
expressly addresses the sequencing question, directing that the
attribute reductions "shall be made after the determination
of the tax imposed ... for the taxable year of the
discharge." (Emphases added.) In order to determine the "tax
imposed," a shareholder must adjust his basis in S corporation
stock and pass through all items of income and loss. Consequently
the 208 attribute reduction must be made after the basis
adjustment and passthrough. Petitioners must pass through the
discharged debt, increase corporate bases, and then deduct their
losses, all before any attribute reduction could occur. Because
their basis increase is equal to their losses, they have no
suspended losses remaining and thus have no net operating losses to
reduce. The primary arguments made in Courts of Appeals against
this reading of the sequencing provision are rejected. Pp.
216-220. 182 F.3d
1143 , reversed.

															THOMAS, J., delivered the opinion of the Court, in which
REHNQUIST, C. J., and STEVENS, O'CONNOR, SCALIA, KENNEDY, SOUTER,
and GINSBURG, JJ., joined. BREYER, J., filed a dissenting opinion, post, p. 220. Darrell D. Hallett argued the cause for petitioners. With
him on the briefs were John M. Colvin and Robert J. Chicoine. Kent L. Jones argued the cause for respondent. With him on the
brief were Solicitor General Waxman, Acting Assistant Attorney
General Junghans, Deputy Solicitor General Wallace, Teresa E.
McLaughlin, and Edward T. Perelmuter. *

															JUSTICE THOMAS delivered the opinion of the Court.

															The Commissioner of Internal Revenue assessed tax deficiencies
against petitioners David and Louise Gitlitz and Philip and Eleanor
Winn because they used nontaxed discharge of indebtedness to
increase their bases in S corporation stock and to deduct suspended
losses. In this case we must answer two questions. First, we must
decide whether the Internal Revenue Code (Code) permits taxpayers
to increase bases in their S corporation stock by the amount of an
S corporation's discharge of indebtedness excluded from gross
income. And, second, if the Code permits such an in-

															* Richard M. Lipton and Theodore R. Bots filed a
brief for the Real Estate Roundtable as amicus curiae urging
reversal. 209 crease, we must decide whether the increase occurs before or
after taxpayers are required to reduce the S corporation's tax
attributes.

															I

															David Gitlitz and Philip Winn 1 were shareholders of P. D. W.
& A., Inc., a corporation that had elected to be taxed under
Subchapter S of the Code, 26 U. S. C. §§ 1361-1379 (1994 ed. and
Supp. III). Subchapter S allows shareholders of qualified
corporations to elect a "pass-through" taxation system under which
income is subjected to only one level of taxation. See Bufferd v. Commissioner, 506 U. S. 523 , 525
(1993). The corporation's profits pass through directly to its
shareholders on a pro rata basis and are reported on the
shareholders' individual tax returns. See § 1366(a)(1)(A).2 To
prevent double taxation of income upon distribution from the
corporation to the shareholders, § 1367(a)(1)(A) permits
shareholders to increase their corporate bases by items of income
identified in § 1366(a) (1994 ed. and Supp. III). Corporate losses
and deductions are passed through in a similar manner, see §
1366(a)(1)(A), and the shareholders' bases in the S corporation's
stock and debt are decreased accordingly, see §§ 1367(a)(2)(B),
1367(b)(2)(A). However, a shareholder cannot take corporate losses
and deductions into account on his personal tax return to the
extent that such items exceed his basis in the stock and debt of
the S corporation. See

															1 Each man filed a joint tax return with his wife. 2 Section
1366(a)(1) provides:

															"In determining the tax under this chapter of a shareholder for
the shareholder's taxable year in which the taxable year of the S
corporation ends ... , there shall be taken into account the
shareholder's pro rata share of the corporation's-

															"(A) items of income (including tax-exempt income), loss,
deduction, or credit the separate treatment of which could affect
the liability for tax of any shareholder .... " 210 § 1366(d)(1) (Supp. III). If those items exceed the basis, the
excess is "suspended" until the shareholder's basis becomes large
enough to permit the deduction. See §§ 1366(d)(1), (2) (1994 ed.
and Supp. III).

															In 1991, P. D. W. & A. realized $2,021,296 of discharged
indebtedness. At the time, the corporation was insolvent in the
amount of $2,181,748. Because it was insolvent even after the
discharge of indebtedness was added to its balance sheet, P. D. W.
& A. excluded the entire discharge of indebtedness amount from
gross income under 26 U. S. C. §§ 108(a) and 108(d)(7)(A). On their
tax returns, Gitlitz and Winn increased their bases in P. D. W.
& A. stock by their pro rata share (50 percent each) of the
amount of the corporation's discharge of indebtedness. Petitioners'
theory was that the discharge of indebtedness was an "item of
income" subject to pass-through under § 1366(a)(1)(A). They used
their increased bases to deduct on their personal tax returns
corporate losses and deductions, including losses and deductions
from previous years that had been suspended under § 1366(d).
Gitlitz and Winn each had losses (including suspended losses and
operating losses) that totaled $1,010,648. With the upward basis
adjustments of $1,010,648 each, Gitlitz and Winn were each able to
deduct the full amount of their pro rata share of P. D. W. &
A.'s losses.

															The Commissioner determined that petitioners could not use P. D.
W. & A.'s discharge of indebtedness to increase their bases in
the stock and denied petitioners' loss deductions. Petitioners
petitioned the Tax Court to review the deficiency determinations.
The Tax Court, in its initial opinion, granted relief to
petitioners and held that the discharge of indebtedness was an
"item of income" and therefore could support a basis increase. See Winn v. Commissioner, 73 TCM 3167 (1997), ~ 97,286
RIA Memo withdrawn and reissued, 75 TCM 1840 (1998), ~ 98,071 RIA
Memo TC. In light of the Tax Court's decision in Nelson v. Commis- 211 sioner, 110 T. C. 114 (1998), aff'd, 182 F.3d
1152 (CAlO 1999),3 however, the Tax Court granted the
Commissioner's motion for reconsideration and held that
shareholders may not use an S corporation's untaxed discharge of
indebtedness to increase their bases in corporate stock. See Winn v. Commissioner, 75 TCM 1840 (1998), ~ 98,071
RIA Memo TC.

															The Court of Appeals affirmed. See 182 F.3d
1143 (CAlO 1999). It assumed that excluded discharge of
indebtedness is an item of income subject to pass-through to
shareholders pursuant to § 1366(a)(1)(A), id., at 1148, 1151, n. 7,
but held that the discharge of indebtedness amount first had to be
used to reduce certain tax attributes of the S corporation under §
108(b), and that only the leftover amount could be used to increase
basis.4 The Court of Appeals explained that, because the tax
attribute to be reduced (in this case the corporation's net
operating loss) was equal to the amount of discharged debt, the
entire amount of discharged debt was absorbed by the reduction at
the corporate level, and nothing remained of the discharge of
indebtedness to be passed through to the shareholders under §
1366(a)(1)(A). Id., at 1151. Because Courts of Appeals have
disagreed on how to treat discharge of indebtedness of an insolvent
S corporation, compare Gaudiano v. Commissioner, 216 F.3d
524 , 535 (CA6 2000) (holding that tax attributes are
reduced before excluded discharged debt income is passed through to
shareholders), cert. pending, No. 00-459; Witzel v. Commissioner, 200 F.3d
496 , 498 (CA7 2000) (same), cert. pending,

															3 In Nelson, the Tax Court held that excluded discharge
of indebtedness does not pass through to an S corporation's
shareholders because § 108 is an exception to normal S corporation
pass-through rules. Specifically, the court held that, because §
108(d)(7)(A) requires that "subsections (a) [and (b) of § 108]
shall be applied at the corporate level" in the case of an S
corporation, it precludes any pass-through of the discharge of
indebtedness to the shareholder level. See Nelson, 110 T. C., at 121-124.

															4 Section 108(b)(1) reads: "The amount excluded from gross
income under [§ 108(a)(1)] shall be applied to reduce the tax
attributes of the taxpayer .... " 212 No. 99-1693; and 182 F. 3d, at 1150 (case below), with United
States v. Farley, 202 F.3d
198 , 206 (CA3 2000) (holding that excluded discharged
debt income is passed through to shareholders before tax attributes
are reduced), cert. pending, No. 99-1675 [REPORTER'S NOTE: See post, p. 1111]; see also Pugh v. Commissioner, 213 F.3d
1324 , 1330 (CAll 2000) (holding that excluded discharged
debt income is subject to pass-through and can increase basis),
cert. pending, No. 00-242, we granted certiorari. 529 U. S. 1097
(2000).

															II

															Before we can reach the issue addressed by the Court of
Appeals-whether the increase in the taxpayers' corporate bases
occurs before or after the taxpayers are required to reduce the S
corporation's tax attributes-we must address the argument raised by
the Commissioner.5 The Commissioner argues that the discharge of
indebtedness of an insolvent S corporation is not an "item of
income" and thus never passes through to shareholders. Under a
plain reading of the statute, we reject this argument and conclude
that excluded discharged debt is indeed an "item of income," which
passes through to the shareholders and increases their bases in the
stock of the S corporation.

															5 The Commissioner has altered his arguments throughout the
course of this litigation. According to the Tax Court, during the
first iteration of this case the Commissioner made several
arguments but then settled on a "final" one-that the discharge of
indebtedness of the insolvent S corporation was not an "item of
income," see 73 TCM 3167 (1997), ~ 97,286 RIA Memo TC. In the Court
of Appeals, the Commissioner argued instead that, because any
pass-through of excluded discharge of indebtedness to petitioners
took place after any reduction of tax attributes and by then the
income would have been fully absorbed by the tax attributes, no
discharged debt remained to flow through to petitioners. The
Commissioner relegated to a footnote his argument that discharge of
indebtedness is not an "item of income." See Brief for Appellee in
Nos. 98-9009 and 98-9010 (CAW), p. 33, n. 14. 213 Section 61(a)(12) states that discharge of indebtedness
generally is included in gross income. Section 108(a)(1) provides
an express exception to this general rule: "Gross income does not include any amount which (but for this
subsection) would be includible in gross income by reason of the
discharge ... of indebtedness of the taxpayer if- "(B) the discharge occurs when the taxpayer is insolvent." The Commissioner contends that this exclusion from gross income
alters the character of the discharge of indebtedness so that it is
no longer an "item of income." However, the text and structure of
the statute do not support the Commissioner's theory. Section
108(a) simply does not say that discharge of indebtedness ceases to
be an item of income when the S corporation is insolvent.
Instead it provides only that discharge of indebtedness ceases to
be included in gross income. Not all items of income are
included in gross income, see § 1366(a)(1) (providing that "items
of income," including "tax-exempt" income, are passed through to
shareholders), so mere exclusion of an amount from gross income
does not imply that the amount ceases to be an item of income.
Moreover, §§ 101 through 136 employ the same construction to
exclude various items from gross income: "Gross income does not
include .... " The consequence of reading this language in the
manner suggested by the Commissioner would be to exempt all items
in these sections from passthrough under § 1366. However, not even
the Commissioner encourages us to reach this sweeping conclusion.
Instead the Commissioner asserts that discharge of indebtedness is
unique among the types of items excluded from gross income because
no economic outlay is required of the taxpayer re- 214 ceiving discharge of indebtedness. But the Commissioner is
unable to identify language in the statute that makes this
distinction relevant, and we certainly find none.

															On the contrary, the statute makes clear that § 108(a)'s
exclusion does not alter the character of discharge of indebtedness
as an item of income. Specifically, § 108(e)(1) reads: "Except as otherwise provided in this section, there shall be no
insolvency exception from the general rule that gross income
includes income from the discharge of indebtedness." This provision presumes that discharge of indebtedness is always
"income," and that the only question for purposes of § 108 is
whether it is includible in gross income. If discharge of
indebtedness of insolvent entities were not actually "income,"
there would be no need to provide an exception to its inclusion in
gross income; quite simply, if discharge of indebtedness of an
insolvent entity were not "income," it would necessarily not be
included in gross income.

															Notwithstanding the plain language of the statute, the
Commissioner argues, generally, that excluded discharge of
indebtedness is not income and, specifically, that it is not
"tax-exempt income" under § 1366(a)(1)(A).6 First, the

															6 The Commissioner also contends, as does the dissent, that
because § 108(d)(7)(A) mandates that the discharged debt amount be
determined and applied to reduce tax attributes "at the corporate
level," rather than at the shareholder level, the discharged debt,
even if it is some type of income, simply cannot pass through to
shareholders. In other words, the Commissioner contends that §
108(d)(7)(A) excepts excluded discharged debt from the general
pass-through provisions for S corporations. However, § 108(d)(7)(A)
merely directs that the exclusion from gross income and the tax
attribute reduction be made at the corporate level. Section
108(d)(7)(A) does not state or imply that the debt discharge
provisions shall apply only "at the corporate leveL" The
very purpose of Subchapter S is to tax at the shareholder level,
not the corporate level. Income is determined at the S corporation
level, see § 1363(b), not in order to tax 215 Commissioner argues that § 108 merely codified the "judicial
insolvency exception," and that, under this exception, discharge of
indebtedness of an insolvent taxpayer was not considered income.
The insolvency exception was a rule that the discharge of
indebtedness of an insolvent taxpayer was not taxable income. See, e. g., Dallas Transfer & Terminal Warehouse Co. v. Commissioner, 70 F.2d 95 (CA5 1934); Astoria Marine
Construction Co. v. Commissioner, 12 T. C. 798 (1949).
But the exception has since been limited by § 108(e). Section
108(e) precludes us from relying on any understanding of the
judicial insolvency exception that was not codified in § 108. And
as explained above, the language and logic of § 108 clearly
establish that, although discharge of indebtedness of an insolvent
taxpayer is not included in gross income, it is nevertheless
income.

															The Commissioner also relies on a Treasury Regulation to support
his theory that no income is realized from the discharge of the
debt of an insolvent: "Proceedings under Bankruptcy Act. "(1) Income is not realized by a taxpayer by virtue of the
discharge, under section 14 of the Bankruptcy Act (11 U. S. C. 32),
of his indebtedness as the result of an adjudication in bankruptcy,
or by virtue of an agreement among his creditors not consummated
under any provision of the Bankruptcy Act, if immediately
thereafter the taxpayer's liabilities exceed the value of his
assets." 26 CFR § 1.61-12(b) (2000). Even if this regulation could be read (countertextually) to
apply outside the bankruptcy context, it merely states that

															the corporation, see § 1363(a) (exempting an S corporation from
income tax), but solely to pass through to the S corporation's
shareholders the corporation's income. Thus, the controlling
provision states that, in determining a shareholder's liability,
"there shall be taken into account the shareholder's pro rata share
of the corporation's ... items of income (including tax-exempt
income) .... " § 1366(a)(1). Nothing in § 108(d)(7)(A) suspends the
operation of these ordinary pass-through rules. 216 "[i]ncome is not realized." The regulation says nothing
about whether discharge of indebtedness is income subject to
pass-through under § 1366.

															Second, the Commissioner argues that excluded discharge of
indebtedness is not "tax-exempt" income under § 1366(a)(1)(A), but
rather "tax-deferred" income. According to the Commissioner,
because the taxpayer is required to reduce tax attributes that
could have provided future tax benefits, the taxpayer will pay
taxes on future income that otherwise would have been absorbed by
the forfeited tax attributes. Implicit in the Commissioner's
labeling of such income as "tax-deferred," however, is the
erroneous assumption that § 1366(a)(1)(A) does not include
"tax-deferred" income. Section 1366 applies to "items of income."
This section expressly includes "tax-exempt" income, but this
inclusion does not mean that the statute must therefore exclude
"tax-deferred" income. The section is worded broadly enough to
include any item of income, even tax-deferred income, that "could
affect the liability for tax of any shareholder." § 1366(a)(1)(A).
Thus, none of the Commissioner's contentions alters our conclusion
that discharge of indebtedness of an insolvent S corporation is an
item of income for purposes of § 1366(a)(1)(A).

															III

															Having concluded that excluded discharge of indebtedness is an
"item of income" and is therefore subject to passthrough to
shareholders under § 1366, we must resolve the sequencing question
addressed by the Court of Appealswhether pass-through is performed
before or after the reduction of the S corporation's tax attributes
under § 108(b). Section 108(b)(1) provides that "[t]he amount
excluded from gross income under [§ 108(a)] shall be applied to
reduce the tax attributes of the taxpayer as provided [in this
section]." Section 108(b)(2) then lists the various tax attributes
to be reduced in the order of reduction. The first tax attribute
to 217 be reduced, and the one at issue in this case, is the net
operating loss. See § l08(b)(2)(A). Section l08(d)(7)(B) specifies
that, for purposes of attribute reduction, the shareholders'
suspended losses for the taxable year of discharge are to be
treated as the S corporation's net operating loss. If tax attribute
reduction is performed before the discharge of indebtedness
is passed through to the shareholders (as the Court of Appeals
held), the shareholders' losses that exceed basis are treated as
the corporation's net operating loss and are then reduced by the
amount of the discharged debt. In this case, no suspended losses
would remain that would permit petitioners to take deductions.7 If,
however, attribute reduction is performed after the
discharged debt income is passed through (as petitioners argue),
then the shareholders would be able to deduct their losses (up to
the amount of the increase in basis caused by the discharged debt).
Any suspended losses remaining then will be treated as the S
corporation's net operating loss and will be reduced by the amount
of the discharged debt. Therefore, the sequence of the steps of
pass-through and attribute reduction determines whether petitioners
here were deficient when they increased their bases by the
discharged debt amount and deducted their losses.

															7 Under this scenario, the shareholders' losses would be reduced
by the discharge of indebtedness. However, it is unclear precisely
what would happen to the discharge of indebtedness. The Court of
Appeals below stated that the discharged debt would be "absorbed"
by the reduction to the extent of the net operating loss and that
therefore only the excess excluded discharged debt would remain to
pass through to the shareholders. 182 F.3d
1143 , 1149 (CAlO 1999). In contrast, another Court of Appeals
suggested, albeit in dictum, that the full amount of the discharge
might still pass through to the shareholder and be used to increase
basis; the discharged debt amount would reduce the net operating
loss but would not be absorbed by it. Witzel v. Commissioner, 200 F.3d
496 , 498 (CA7 2000). We need not resolve this issue
because we conclude that the discharge of indebtedness passes
through before any attribute reduction takes place. 218 The sequencing question is expressly addressed in the statute.
Section 108(b)(4)(A) directs that the attribute reductions "shall
be made after the determination of the tax imposed by
this chapter for the taxable year of the discharge." (Emphases
added.) See also § 1017(a) (applying the same sequencing when § 108
attribute reduction affects basis of corporate property). In order
to determine the "tax imposed," an S corporation shareholder must
adjust his basis in his corporate stock and pass through all items
of income and loss. See §§ 1366, 1367 (1994 ed. and Supp. III).
Consequently, the attribute reduction must be made after the
basis adjustment and pass-through. In the case of petitioners, they
must pass through the discharged debt, increase corporate bases,
and then deduct their losses, all before any attribute reduction
could occur. Because their basis increase is equal to their losses,
petitioners have no suspended losses remaining. They, therefore,
have no net operating losses to reduce.

															Although the Commissioner has now abandoned the reasoning of the
Court of Appeals below,8 we address the pri-

															8 The Commissioner has abandoned his argument related to the
sequencing issue before this Court. This abandonment is
particularly odd given that the sequencing issue predominated in
the Commissioner's argument to the Court of Appeals.
Notwithstanding the Commissioner's attempt at oral argument to
distance himself from the reasoning of the Court of Appeals on this
issue-the Commissioner represented to us that the Court of Appeals
developed its reading of the statute sua sponte, Tr. of Oral
Arg. 22-24, 27-it is apparent from the Commissioner's brief in the
Court of Appeals that the Commissioner supplied the very
sequencing theory that the Court of Appeals adopted. Compare, e. g., Brief for Appellee in Nos. 98-9009 and 98-9010 (CAW),
p. 28 ("First, the discharge of indebtedness income that is
excluded under Section 108(a) at the corporate level is temporarily
set aside and has no tax consequences .... Second, PDW & A
computes its tax attributes, i. e., taxpayers' suspended
losses. Third, the excluded discharge of indebtness income is
applied against and eliminates the suspended losses. Because the
excluded income is applied against-and offset by-the suspended
losses, no item of income flows through to taxpayers under Section
1366(a), and no upward basis adjust- 219 mary arguments made in the Courts of Appeals against
petitioners' reading of the sequencing provision. First, one court
has expressed the concern that, if the discharge of indebtedness is
passed through to the shareholder before the tax attributes
are reduced, then there can never be any discharge of indebtedness
remaining "at the corporate level," § 108(d)(7)(A), by which to
reduce tax attributes.9 Gaudi ano, 216 F. 3d, at 533. This
concern presumes that tax attributes can be reduced only if the
discharge of indebtedness itself remains at the corporate level.
The statute, however, does not impose this restriction. Section
108(b)(1) requires only that the tax attributes be reduced by
"[t]he amount excluded from gross income" (emphasis added), and
that amount is not altered by the mere pass-through of the income
to the shareholder.

															Second, courts have discussed the policy concern that, if
shareholders were permitted to pass through the discharge of
indebtedness before reducing any tax attributes, the shareholders
would wrongly experience a "double windfall":

															ment is made under Section 1367(a)" (citations omitted)), with, e. g., 182 F. 3d, at 1151 ("PDW & A first must
compute its discharge of indebtedness income and set this figure
aside temporarily. The corporation then must calculate its net
operating loss tax attribute .... Finally, the corporation must
apply the excluded discharged debt to reduce its tax attributes. In
this case, the net operating loss tax attribute fully absorbs the
corporation's excluded discharge of indebtedness income. Thus,
there are no items of income to pass through to Gitlitz and
Winn").

															9 Similar to this argument is the contention that, in cases such
as this one in which the shareholders' suspended losses are fully
deducted before attribute reduction could take place, no net
operating loss remains and no attribute reduction can occur, thus
rendering § 108(b) inoperative. However, there will be other cases
in which § 108(b) will be inoperative. In particular, if a taxpayer
has no tax attributes at all, there will be no reduction. Certainly
the statute does not condition the exclusion under § 108(a) on the
ability of the taxpayer to reduce attributes under § 108(b).
Likewise, in the case of shareholders similarly situated to
petitioners in this case, there is also the possibility that other
attributes, see §§ 108(b)(2)(B)-(G), could be reduced. 220 They would be exempted from paying taxes on the full amount of
the discharge of indebtedness, and they would be able to
increase basis and deduct their previously suspended losses. See, e. g., 182 F. 3d, at 1147-1148. Because the Code's plain
text permits the taxpayers here to receive these benefits, we need
not address this policy concern.10

															***

															The judgment of the Court of Appeals, accordingly, is
reversed.

															It is so ordered.

															JUSTICE BREYER, dissenting.

															I agree with the majority's reasoning with the exception of
footnotes 6 and 10. The basic statutory provision before us is 26
U. S. C. § 108-the provision that excludes from the "gross income"
of any "insolvent" taxpayer, income that cancellation of a debt
(COD) would otherwise generate. As the majority acknowledges,
however, ante, at 214-215, n. 6, § 108 contains a subsection
that sets forth a special exception. The exception, entitled
"Special rules for S corporation," says:

															10 The benefit at issue in this case arises in part because §
108(d)(7)(A) permits the exclusion of discharge of indebtedness
income from gross income for an insolvent S corporation even when
the S corporation shareholder is personally solvent. We are aware
of no other instance in which § 108 directly benefits a solvent
entity. However, the result is required by statute. Between 1982
and 1984, § 108 provided that the exclusion from gross income and
the reduction in tax attributes occurred at the shareholder level.
See Subchapter S Revision Act of 1982, Pub. L. 97-354, § 3(e), 96
Stat. 1689. This provision, which paralleled the current taxation
of partnerships at the partner level, see 26 U. S. C. § 108(d)(6),
prevented solvent shareholders from benefiting as a result of their
S corporation's insolvency. In 1984, however, Congress amended the
Code to provide that § 108 be applied "at the corporate level." Tax
Reform Act of 1984, Pub. L. 98-369, § 721(b), 98 Stat. 966. It is
as a direct result of this amendment that the solvent petitioners
in this case are able to benefit from § 108's exclusion. 221 "(A) Certain provisions to be applied at corporate level. "In the case of an S corporation, subsections (a), (b), (c), and
(g) shall be applied at the corporate level." 26 U. S. C. §
108(d)(7)(A). If one reads this language literally as exclusive, both the COD exclusion (§ 108(a)) and the tax attribute reduction (§
108(b)) would apply only "at the corporate level." Hence the COD income would not flow through to S corporation
shareholders. Consequently, the insolvent S corporation's COD income would not increase the shareholder's basis and
would not help the shareholder take otherwise unavailable
deductions for suspended losses.

															The Commissioner argues that we should read the language in this
way as preventing the flow-through of the corporation's COD income. Brief for Respondent 27. He points to the language of a
House Committee, which apparently thought, when Congress passed an
amendment to § 108, that the Commissioner's reading is correct. H.
R. Rep. No. 103-111, pp. 624-625 (1993) ("[T]he exclusion and basis
reduction are both made at the S corporation level (sec.
108(d)(7)). The shareholders' basis in their stock is not adjusted
by the amount of debt discharge income that is excluded at the
corporate level"). At least one commentator believes the same. See
Loebl, Does the Excluded COD Income of an Insolvent S
Corporation Increase the Basis of the Shareholders' Stock?, 52 U.
Fla. L. Rev. 957, 981-988 (2000). But see Lockhart & Duffy, Tax
Court Rules in Nelson That S Corporation Excluded COD Income Does Not Increase Shareholder Stock Basis, 25 Wm. Mitchell
L. Rev. 287 (1999).

															The Commissioner finds support for his literal, exclusive
reading of § 108(d)(7)(A)'s language in the fact that his reading
would close a significant tax loophole. That loopholepreserved by
the majority-would grant a solvent shareholder of an
insolvent S corporation a tax benefit in the form of permission to
take an otherwise unavailable deduction, 222 thereby sheltering other, unrelated income from tax. See Witzel v. Commissioner, 200 F.3d
496 , 497 (CA7 2000) (Posner, C. J.) ("It is hard to
understand the rationale for using a tax exemption to avoid
taxation not only on the income covered by the exemption but also
on unrelated income that is not tax exempt"). Moreover, the benefit
often would increase in value as the amount of COD income
increases, a result inconsistent with congressional intent to
impose a "price" (attribute reduction), see Lipton, Different
Courts Adopt Different Approaches to the Impact of COD Income on S
Corporations, 92 J. Tax. 207 (2000), on excluded COD. Further, this
deduction-related tax benefit would have very different tax
consequences for identically situated taxpayers, depending only
upon whether a single debt can be split into segments, each of
which is canceled in a different year. For example, under the
majority's interpretation, a $1 million debt canceled in one year
would permit Taxpayer A to deduct $1 million of suspended losses in
that year, thereby permitting A to shelter $1 million of unrelated
income in that year. But because § 108 reduces tax attributes after
the first year, five annual cancellations of $200,000 will not
create a $1 million shelter. Timing is all important.

															The majority acknowledges some of these policy concerns and
confesses ignorance of any "other instance in which § 108 directly
benefits a solvent entity," but claims that its reading is mandated
by the plain text of § 108(d)(7)(A) and therefore that the Court
may disregard the policy consequences. Ante, at 220, n. 10.
It is difficult, however, to see why we should interpret that
language as treating different solvent shareholders differently,
given that the words "at the corporate level" were added "[i]n
order to treat all shareholders in the same manner." H. R. Rep. No.
98-432, pt. 2, p. 1640 (1984). And it is more difficult to see why,
given the fact that the "plain language" admits either
interpretation, we should ignore the policy consequences. See Commissioner v. Gillette Motor Transport, Inc., 364 U. S. 130 ,
134-135 223 (1960) (abandoning literal meaning of 26 U. S. C. § 1221 (1958
ed.) for a reading more consistent with congressional intent).
Accord, Commissioner v. P. G. Lake, Inc., 356 U. S. 260 ,
264267 (1958); Corn Products Refining Co. v. Commissioner, 350 U. S. 46, 51-52 (1955); Hort v. Commissioner, 313 U. S. 28 , 30-31
(1941).

															The arguments from plain text on both sides here produce
ambiguity, not certainty. And other things being equal, we should
read ambiguous statutes as closing, not maintaining, tax loopholes.
Such is an appropriate understanding of Congress' likely intent.
Here, other things are equal, for, as far as I am aware, the
Commissioner's literal interpretation of § 108(d)(7)(A) as
exclusive would neither cause any taxrelated harm nor create any
statutory anomaly. Petitioners argue that it would create a
linguistic inconsistency, for they point to a Treasury Regulation
that says that the Commissioner will apply hobby loss limitations
under § 183 "at the corporate level in determining" allowable
deductions, while, presumably, nonetheless permitting the deduction
so limited to flow through to the shareholder. Treas. Reg. §
1.183-1(f), 26 CFR § 1.183-1(f) (2000). But we are concerned here
with the "application" of an exclusion, not with "determining" the amount of a deduction. Regardless, the
regulation's use of the words "at the corporate level," like the
three other appearances of the formulation "applied" or
"determined" "at the corporate level" in the Code, occur in
contexts that are so very different from this one that nothing we
say here need affect their interpretation. See 26 U. S. C. §
49(a)(1)(E)(ii)(I) (determining whether financing is recourse
financing); 26 U. S. C. § 264(f)(5)(B) (1994 ed., Supp. III)
(determining how to allocate interest expense to portions of
insurance policies); 26 U. S. C. § 302(e)(1)(A) (determining
whether a stock distribution shall be treated as a partial
liquidation). If there are other arguments militating in favor of
the majority's interpretation, I have not found them. 224 The majority, in footnote 6, says that the words "at the
corporate level" in § 108(d)(7)(A) apply to the exclusion of COD income from corporate income and to "tax attribute
reduction," but do not "suspen[d] the operation of ... ordinary
pass-through rules" because § 108(d)(7)(A) "does not state or imply
that the debt discharge provisions shall apply only 'at the
corporate level.' " It is the majority, however, that should
explain why it reads the provision as nonexclusive (where, as here,
its interpretation of the Code results in the "practical equivalent
of [a] double deduction," Charles Ilfeld Co. v. Hernandez, 292
U. S. 62 , 68 (1934)). See United States v. Skelly Oil
Co., 394 U. S.
678 , 684 (1969) (requiring "clear declaration of intent by
Congress" in such circumstances). I do not contend that §
108(d)(7)(A) must be read as having exclusive effect, only
that, given the alternative, this interpretation provides the best
reading of § 108 as a whole. And I can find no "clear declaration
of intent by Congress" to support the majority's contrary
conclusion regarding § 108(d)(7)(A)'s effect. It is that conclusion
from which, for the reasons stated, I respectfully dissent.

Summary: The Supreme Court held that discharged debt is considered an "item of income" for shareholders of an S corporation, allowing them to increase their bases in the corporation's stock and deduct losses. However, the Court also determined that the amount of discharged debt must first be used to reduce the corporation's tax attributes under the tax code.