8696 / To which taxpayers do the passive rules apply?

IRC Section 469, which governs the treatment of passive losses, applies to individual taxpayers, estates and trusts. Closely-held C corporations and personal service corporations are also subject to the passive loss rules in an attempt to prevent taxpayers from creating these entities solely to avoid the passive loss rules (see Q 8695).¹

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Planning Point: Even though the passive activity rules do not apply to grantor trusts, partnerships, and S corporations directly, they do apply to the owners of these entities (i.e., they are applied at the individual level, rather than the entity level).²

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The passive loss rules apply to S corporations and partnerships indirectly, because income and losses flow through the entity to apply at the individual taxpayer level (e.g., to the S corporation’s shareholders or partnership’s partners). See Q 8967 and Q 8930 for a detailed discussion of the pass-through rules applicable to S corporations and partnerships, respectively.