Rev. Rul. 69-125

Advice has been requested whether, under the circumstances described below, the phrase "indebtedness of the corporation to the shareholder" as used in section 1374(c)(2)(B) of the Internal Revenue Code of 1954 includes an indebtedness owed by an electing small business corporation to a partnership.

The majority shareholders of X, an electing small business corporation, are equal partners in a partnership and own a majority of the interests in the partnership. The partnership, although not engaged in the business of lending money, has lent large sums of money to X.

X had a net operating loss for its last taxable year and, at the close of that taxable year, still owed large sums of money to the partnership.

Section 1374(a) of the Code provides, in general, that a net operating loss of an electing small business corporation for any taxable year shall be allowed as a deduction from gross income of the shareholder.

Section 1374(c) of the Code provides, in part, as follows:

"(2) Limitation.--A shareholder's portion of the net operating loss of an electing small business corporation for any taxable year shall not exceed the sum of--

"(A) the adjusted basis * * * of the shareholder's stock in the electing small business corporation, determined as of the close of the taxable year of the corporation * * *, and

"(B) the adjusted basis * * * of any indebtedness of the corporation to the shareholder, determined as of the close of the taxable year of the corporation * * *."

Section 1374(c)(2)(B) of the Code encompasses only a debt of the corporation that runs directly to the shareholder. See William H. Perry v. Commissioner, 47 T.C. 159 (1966), affirmed 392 F. (2d) 458 (1968).

The debts owed by X corporation to the partnership, however, are not "indebtedness of the corporation to the shareholder" within the meaning of section 1374(c)(2)(B) of the Code. Accordingly, the limit on the amount of the net operating loss of X corporation that the shareholders may take into account does not include the partnership loans to X corporation.