Under Section 1377(a)(1), how is S corporation income and loss allocated to a shareholder who disposes of all their shares during the tax year?
- The departing shareholder reports all income and loss for the entire year.
- The departing shareholder reports none of the income or loss for the year.
- All income is allocated to the remaining shareholders as of the disposal date.
- Under the daily proration method (default), the departing shareholder is allocated income or loss based on the number of days they owned the stock relative to the total days in the tax year; alternatively, the parties may elect a closing-of-books method to make an interim closing at the date of sale. (correct answer)
Explanation: Under Section 1377(a)(1), the default method for allocating S corporation income to a shareholder who sells their shares is the daily proration method: the departing shareholder's allocated share equals their percentage ownership multiplied by the pro-rata portion of the year they owned the shares (days owned / total days). Alternatively, under Section 1377(a)(2), if all affected shareholders consent, the corporation may make an interim closing of the books at the date of the disposition, allocating income and loss based on actual results through that date. Answer A is incorrect because the entire year's allocation goes to the departing shareholder only under specific circumstances. Answer B is incorrect because the departing shareholder is allocated their pro-rata share. Answer C is incorrect because the departing shareholder retains their allocated share for their ownership period.