Gitlitz, et al. v. Commissioner of Internal Revenue
Jan 10, 2001OUTCOME: Taxpayers Win Victory in US Supreme Court:
Taxpayers Win Victory in US Supreme Court: COURT SAYS TAXPAYERS PERMITTED TO INCREASE BASIS IN THEIR “S†CORPORATION STOCK BY DISCHARGE OF INDEBTEDNESS (Washington D.C.- January 10, 2001) Taxpa ... yers have won a major victory in the United States Supreme Court, lawyers for Petitioners, David Gitlitz and Philip Winn, announced today. Winn served in the U.S. Department of Housing and Urban Development during the Reagan Administration. The case (Gitlitz, et al. v. Commissioner of Internal Revenue, 531 U.S. ___ [2001]) involves a complex tax issue which was addressed by the United States Tax Court and five different Courts of Appeals. Because the Courts of Appeals were in disagreement, the U.S. Supreme Court agreed to resolve the dispute. The Supreme Court’s January 9, 2001 decision overrules the opinions of the U.S. Tax Court and the 10th Circuit Court of Appeals, both of which had been unanimous in favor of the IRS. “This is one of three or four favorable U.S. Supreme Court decisions for taxpayers in the last 10 years, as compared to about a dozen losses,†said Darrell Hallett of the Seattle law firm, Chicoine & Hallett, PS, (www.chicoine-hallett.com) who argued the case before the Court on October 2, 2000. “We expect this case to have sweeping effects,†he said. “The government stated that it has more than 30 other cases raising this same issue currently pending in the courts, and many more may be on audit before the IRS,†Hallett said. “This critical clarification of the Tax Code by the Court should save taxpayers millions of dollars both in actual taxes and litigation costs,†he added. In its 8-1 decision, the Court held that the Internal Revenue Code permits taxpayers to increase the basis in their S corporation stock by the amount of an S Corporation’s discharge of indebtedness excluded from gross income. Justice Thomas delivered the opinion of the Court. Justice Breyer filed the only dissenting opinion. The case dates from 1991, when P.D.W. & A, Inc. of Colorado, an insolvent S corporation, of which David Gitlitz and Philip Winn were shareholders, excluded over $2 million in discharge of indebtedness from gross income, under Section 108 of the Internal Revenue Code. On their personal returns, shareholders Gitlitz and Winn increased the basis in their S corporation by the amount of the discharge. Gitlitz and Winn claimed additional corporate losses and deductions because of the increase in basis. The Internal Revenue Service disagreed. Gitlitz and Winn petitioned the United States Tax Court, which, after first issuing an opinion in favor of the Taxpayers, ultimately held that shareholders of S corporations cannot use the corporation's untaxed discharge of indebtedness to increase their basis in the S corporation stock. The 10th Circuit Court of Appeals affirmed the Tax Court’s decision. The U.S. Supreme Court overturned the lower courts' decisions and rejected the IRS’s argument that discharge of indebtedness of an insolvent corporation is not an “item of income,†and thus never passes through to shareholders under §1366(a)(1)(A). This was controversial and provoked extensive questioning at oral argument. Justice Scalia commented that this was the first time he could remember the IRS arguing that something was not income. The Court ultimately rejected this argument. As to the IRS’s "concern" that shareholders would have “double windfall†as a result of not paying taxes on the discharged debt but also being able to increase basis and deduct suspended losses, the Court wrote “[b]ecause the Codes’ plain text permits the taxpayers here to receive these benefits, we need not address this policy concern.†Hallett commented, “The Court has affirmed that the language of the statutes must be given its ordinary meaning, even when the government doesn’t like it.â€
