                        T.C. Memo. 2000-30



                      UNITED STATES TAX COURT



      ROBERT H. AND MILDRED M. BETTISWORTH, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 12447-98.               Filed January 21, 2000.



     Richard W. Hompesch II, for petitioners.

    Stephen P. Baker, for respondent.



                        MEMORANDUM OPINION


     JACOBS, Judge:   Respondent determined a $45,715 deficiency in

petitioners’ 1994 Federal income tax.     The deficiency primarily

stems from the disallowance of a net operating loss carryover due

to insufficient basis in petitioners’ S corporation stock.

     The underlying issue for decision is whether discharge of
                                        - 2 -

indebtedness income excluded from an S corporation’s gross income

under    section    108(a)     passes    through     to     the    S   corporation’s

shareholders       and,   if   it   does,       increases    the       basis   of   the

shareholder’s stock under section 1367. We addressed this issue in

Nelson v. Commissioner, 110 T.C. 114 (1998), affd. 182 F.3d 1152

(10th Cir. 1999), wherein we held that cancellation of debt (COD)

income excluded by section 108(a) does not pass through to a

shareholder of an S corporation as an item of income under section

1366(a)(1)(A) so as to allow a corresponding increase in the basis

of the shareholder’s stock under section 1367(a)(1).1                     Petitioners

do not agree with our holding in Nelson and request us to “review

and revise” that holding.

     All section references are to the Internal Revenue Code as in

effect for the year in issue.           All Rule references are to the Tax

Court Rules of Practice and Procedure.

        This case was submitted fully stipulated under Rule 122.                    The

stipulation of facts and the exhibits submitted therewith are

incorporated herein by this reference.




     1
          Nelson v. Commissioner, 110 T.C. 114 (1998), affd. 182
F.3d 1152 (10th Cir. 1999), was affirmed for the reasons
explained by the U.S. Court of Appeals for the Tenth Circuit in
Gitlitz v. Commissioner, 182 F.3d 1143 (10th Cir. 1999), affg.
Winn v. Commissioner, T.C. Memo. 1998-71, which was decided on
the same day as Nelson.
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Background

      Petitioners, husband and wife, resided in Fairbanks, Alaska,

at the time they filed their petition in this case.

      At all relevant times, Robert H. Bettisworth (petitioner) was

a   33.3-percent      shareholder   in    Narwhal,    Inc.   (Narwhal),     an   S

corporation. At the end of 1992, petitioner’s basis in his Narwhal

stock was zero; in 1993, his basis increased to $68,125 as a result

of a loan he made to the corporation.

      Narwhal was in the business of developing real estate. In

1993, Narwhal was forced to surrender most of its real estate

holdings through foreclosure.            As a result, Narwhal realized COD

income of $3,321,471.         Because Narwhal was insolvent, the COD

income was treated as nontaxable pursuant to section 108.                    For

1993, Narwhal had ordinary losses of $2,586,238.

      Narwhal issued petitioner a Schedule K-1 for 1993, reflecting

his distributive share of Narwhal’s COD income ($1,107,155) and

ordinary losses ($862,078).         Petitioner increased the basis in his

Narwhal stock by the amount of his distributive share of Narwhal’s

COD income, and amended returns were filed in order to take

advantage of previously disallowed net operating losses (NOL’s).2

The   NOL’s    were   first   carried     back   3   years   and   then   carried




      2
              Before 1993, petitioners had $275,323 in suspended
losses.
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forward.3    In 1994, petitioners used an NOL carryover of $154,971.4

      In the notice of deficiency, respondent determined that the

use of Narwhal’s excluded COD income to increase the basis of

petitioner’s    stock    was    improper        and       consequently      there       was

insufficient basis for petitioners to use the NOL carryovers.

Respondent made other adjustments to petitioners’ 1994 return based

on the disallowance of the NOL’s.               The parties agree that these

adjustments are computational and turn on our resolution of the NOL

issue.

Discussion

      Section 1366(d) provides that the aggregate amount of losses

and   deductions    taken     into    account       by    a   shareholder    of        an   S

corporation cannot exceed the sum of:                    (1) The adjusted basis of

the   shareholder’s     stock    in     the     S   corporation;      and        (2)    the

shareholder’s      adjusted     basis     of    any       indebtedness      of    the       S

corporation to the shareholder. Petitioners maintain that they are

entitled to increase the basis in their Narwhal stock by their

distributive share of COD income and accordingly should be allowed

to deduct certain NOL’s.

      Petitioners make no attempt to distinguish their case from

      3
          Petitioners carried back a total of $85,654 in
suspended losses to 1990, 1991, and 1992. The remaining $991,995
was then carried forward.
      4
          Petitioners claimed a $164,197 NOL carryover on their
amended 1994 return. We are unable to account for this
discrepancy.
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Nelson.   Rather, they contend that in Nelson we failed adequately

to address the following legal issues:       (1) Whether COD income is

an item of income that increases basis; (2) whether COD income

constitutes tax-exempt income which passes through to shareholders;

(3) whether section 108(d)(7)(A) operates as an exception to the

general pass-through scheme of sections 1366 and 1367; and (4)

whether Nelson is inconsistent with our holding in CSI Hydrostatic

Testers, Inc. v. Commissioner, 103 T.C. 398 (1994), affd. per

curiam 62 F.3d 136 (5th Cir. 1995).       We disagree with petitioners.

Nelson addressed all of these issues. See Nelson v. Commissioner,

supra at 121-129.   Our opinion in Nelson controls the situation

involved herein; consequently, we sustain respondent’s disallowance

of the claimed NOL carryover.5

     To reflect the foregoing,



                                              Decision will be entered

                                         for respondent.




     5
           We are mindful that the U.S. District Court for the
District of Oregon recently held that COD income excluded from
gross income under sec. 108(a) passes through to the shareholders
of an S corporation, allowing them to increase the basis of their
stock under sec. 1367. See Hogue v. United States, ___ F. Supp.
2d ___ (D. Or. Jan. 3, 2000). We believe this decision to be
erroneous.
