Rule: IRC Section 1366 controls the pass-through of S corporation income items to shareholders. In general, items are divided into separately stated items (items that could potentially affect the tax liability of the shareholders) and non-separately stated items. Non-separately stated items are lumped together and constitute the S corporation's ordinary income. Separately stated items are passed through to the shareholders (in a manner similar to partnerships) and retain their tax attributes to the shareholders. Choice "D" is correct. Tap's ordinary income is calculated as follows:
Revenue
$ 44,000
Operating expenses
(20,000)
Interest expense
(4,000)
Ordinary income
$ 20,000
The long-term capital loss and the charitable contributions are not included in Tap's ordinary income. They are separately stated items and thus are passed through to the shareholders and retain their tax attributes. Choice "b" is incorrect. The $13,000 would include both the long-term capital loss and the charitable contributions.
Choice "a" is incorrect. The $19,000 would include the long-term capital loss but not the charitable contributions.
Choice "c" is incorrect. The $24,000 would not include the interest expense.
