Chapter 11, Problem 1DQ

To determine

Identify the two rules designed to limit the tax benefits a tax payer may obtain from a tax shelter investment. Explain the manner these rules reduce or defer the recognized tax losses.

Explanation of Solution

The two rules designed to limit the tax benefits a tax payer may obtain from a tax shelter investment are “at-risk provisions” and “passive activity loss rules”.

The at-risk provisions are relevant to individuals and closely held corporations. As per these rules, a taxpayer’s allowable loss from an activity for any taxable year is restricted to the amount the taxpayer has at risk at the end of that taxable year.

The passive activity loss rules are relevant to individuals, estates, trusts, personal service corporations, and closely held C corporations. Usually, the rules offer that losses or expenses due to the passive activities can be allowed only to the amount of income from the entire amount of the taxpayer’s passive activities. On the other hand, closely held C corporations (other than PSCs) may perhaps use passive activity losses to offset active other than the portfolio income.

Under both sets of rules, losses that are disallowed in the present year might be carried forward to future years where they may provide a tax benefit.