EA Exam Part 2 / Businesses

S Corporation Cancellation of Debt Practice Question

Work the complete fact pattern before revealing the explanation. This question is adapted from the IRS public sample set for the current exam law period.

By Jordan AshbyUpdated August 13, 2026Adapted from the IRS sample set

Question

Which statement is correct about cancellation of debt income for an S corporation?

A
It flows to shareholders when the corporation excludes it
B
It is always recognized regardless of insolvency
C
It cannot be excluded in a Chapter 11 reorganization
D
It flows to shareholders when the S corporation does not exclude it
Correct answer

Why the answer works

It flows to shareholders when the S corporation does not exclude it

Cancellation of debt income that is not excluded at the S corporation level passes through to shareholders.

Reference testedIRC 108(a)(1), 108(d)(7), 1366(a)(1) and 1377(a)(1)

Make this useful on the next question

Transfer the reasoning, not the wording.

Restate the tested rule without the answer choices. Then change one decisive fact and explain which option would need to change. That short exercise makes the explanation retrievable instead of merely familiar.

Official sample source

PassFast adapted this public IRS sample for web practice and added the concise explanation above.