If a deduction comprises both an item that is attributable to the taxpayer's interest in the entity and an item or items that are not attributable to the interest in the entity, and if the deduction is limited by a provision of the Code (such as section 170(b), relating to limitations on charitable contributions), the deduction must be prorated among the items taken into account in computing the deduction. For example, if an individual makes a charitable contribution of $5,000 and his distributive share of a partnership includes $2,000 in charitable contributions made by the partnership, and if the charitable contribution deduction is limited to $3,500 under section 170(b), then the portion of the deduction allowed to the taxpayer that is not attributable to a specific activity is $2,500 ($3,500 * ($5,000 ÷ $7,000)) and the portion of the deduction allowed to the taxpayer that is attributable to the interest in the partnership is $1,000 ($3,500 * ($2,000 ÷ $7,000)).
Salary | $3,000 |
Undistributed taxable income: | |
Ordinary income | 8,000 |
Net capital gain | 2,000 |
Total | 10,000 |
Total | 13,000 |
A has income from other activities:
Ordinary income | 6,000 |
Net capital gain | 4,000 |
Total | 10,000 |
Gross income: | |
Income from S Corporation | $13,000 |
Income from other sources | 10,000 |
Total | 23,000 |
Less: Deductions attributable to specific activities: | |
Section 1202 deduction (50 percent. of $6,000) | 3,000 |
A's gross income reduced by the amount of the deductions attributable to specific activities (denominator of the ratio for determining the proportionate share of deductions not attributable to a specific activity) | 20,000 |
Income from S Corporation that A is required to include in gross income: | |
Ordinary income | $11,000 |
Net capital gain | 2,000 |
Total | 13,000 |
Less: Deductions of the taxpayer attributable to the interest in S Corporation: | |
Section 1202 deduction (50 pct. of $2,000) | 1,000 |
(Numerator of the ratio for determining the proportionate share of deductions not attributable to a specific activity) | 12,000 |
Less: Proportionate share of the deductions of the taxpayer not attributable to a specific activity: | |
Personal exemption deduction ($750 * $12,000/$20,000) | 450 |
Zero bracket amount ($2,200 * $12,000/$20,000) | 1,320 |
Total | 1,770 |
Portion of A's taxable income attributable to interest in S Corporation. | 10,230 |
Ordinary income (other than guaranteed payment) | $38,420 |
Guaranteed payment | 20,000 |
Net long-term capital gain | 6,000 |
Net short-term capital loss | 2,000 |
Dividends qualifying for exclusion | 100 |
Charitable contributions | 500 |
C also has items of income from other sources and deductions, as follows:
Ordinary income | $21,680 |
Short-term capital gain | 2,000 |
Dividends qualifying for exclusion | 400 |
Deductions: | |
Deductible medical expenses | 16,000 |
Charitable contributions | 4,000 |
Alimony | 18,000 |
Interest and taxes on home | 8,000 |
Loss relating to another specific activity | 4,000 |
Gross income: Income from the partnership: | |
Ordinary income | $58,420 |
Net long-term capital gain | 6,000 |
Dividends | 100 |
Less: Proportionate share of dividend exclusion ($100 * $100/$500) | 20 |
80 | |
64,500 | |
Income from other sources: | |
Ordinary income | 21,680 |
Net short/term capital gain | 2,000 |
Dividends | 400 |
Less: Proportionate share of dividend exclusion ($100 * $400/$500) | $80 |
320 | |
24,000 | |
88,500 | |
Less: Deductions attributable to specific activities: | |
Net short-term capital loss passed through the partnership | 2,000 |
Loss related to another specific activity | 4,000 |
Section 1202 deduction attributable to the interest in the partnership | 2,000 |
Charitable contribution deduction passed through the partnership | 500 |
8,500 | |
C's gross income, reduced by the amount of the deductions attributable to specific activities (denominator of the ratio for determining the proportionate share of deductions not attributable to a specific activity) | 80,000 |
Distributive share of ordinary income (other than guaranteed payments) | $38,420 |
Guaranteed payment | 20,000 |
Distributive share of dividends less share of exclusion | 80 |
Distributive share of net long-term capital gain | 6,000 |
64,500 | |
Section 1202 deduction (50 pct. of $4,000) | 2,000 |
Charitable contribution passed through the partnership | 500 |
Net short-term capital loss passed through the partnership | 2,000 |
4,500 | |
(Numerator of the ratio for determining the proportionate share of deductions not attributable to a specific activity) | 60,000 |
Section 1202 deduction ($1,000 * $60,000/$80,000) | 750 |
Deductible medical expenses ($16,000 * $60,000/$80,000) | 12,000 |
Charitable contributions ($4,000 * $60,000/$80,000) | 3,000 |
Alimony ($18,000 * $60,000/$80,000) | 13,500 |
Interest and taxes on home ($8,000 * $60,000/$80,000) | 6,000 |
Personal exemption deduction ($3,000 * $60,000/$80,000) | 2,250 |
Total | 37,500 |
Portion of C's taxable income attributable to the interest in the partnership | 22,500 |
C has a deduction under section 1202 of $3,000. Of that deduction, $2,000 is attributable directly to C's interest in the partnership (50 percent of the net capital gain that would result from offsetting the $6,000 net long-term capital gain and the $2,000 net short-term capital loss that are attributable to C's interest in the partnership). Since the remaining $1,000 deduction under section 1202 cannot be attributed directly to either C's income from the partnership or any other specific activity, it must be treated as a deduction not attributable to a specific activity.
26 C.F.R. §1.53-3
Secs. 44B, 381, and 7805 of the Internal Revenue Code of 1954 (92 Stat. 2834, 26 U.S.C. 44B ); 91 Stat. 148, 26 U.S.C. 381(c)(26) ; 68A Stat. 917, 26 U.S.C. 7805