Underwood v. C. I. R., 75-1625
| Citation | 535 F.2d 309 |
| Decision Date | 19 July 1976 |
| Docket Number | No. 75-1625,75-1625 |
| Parties | 76-2 USTC P 9557 Morris G. UNDERWOOD and Jackie Underwood, Individuals, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. |
| Court | United States Courts of Appeals. United States Court of Appeals (5th Circuit) |
Edward R. Smith, Lubbock, Tex., for petitioners-appellants.
Scott P. Crampton, Meyer Rothwacks, Wynette J. Hewett, Asst. Attys. Gen., Tax Div., Dept. of Justice, Gilbert E. Andrews, Acting Chief, Tax Div., Appellate Sect., Dept. of Justice, Meade Whitaker, IRS, Chief Counsel, Washington, D. C., for respondent-appellee.
Appeal from the Decision of the United States Tax Court (Texas Case).
Before GEWIN, GODBOLD and SIMPSON, Circuit Judges.
This is an appeal from a decision of the United States Tax Court finding a deficiency in the taxpayers' federal income tax for the year 1969 in the aggregate amount of $8,788.66. The findings of fact of the Tax Court and the opinion of Judge Featherston were entered on January 27, 1975 and are reported at 63 T.C. 62. We affirm.
Taxpayers Morris G. Underwood and Jackie Underwood, husband and wife, are the sole shareholders of two corporations engaged in the retail barbecue cafeteria business, Underwood's Of Lubbock, Inc. (hereinafter Lubbock) and Underwood's of Albuquerque, Inc. (hereinafter Albuquerque). As of May, 1966, Albuquerque elected to be taxed as a small business corporation under Subchapter S of the Internal Revenue Code, 26 U.S.C. §§ 1371-79; Lubbock did not so elect. From the outset the Lubbock operation had been consistently profitable; Albuquerque, on the other hand, was continually unprofitable. To help finance the latter's fledgling operations, from January, 1965 until October, 1966 Lubbock made a series of loans to Albuquerque totaling $110,000. In return, the Subchapter S corporation executed a series of demand notes to Lubbock, each bearing six percent interest.
An electing small business corporation under Subchapter S is not subject to the corporate income tax, § 1372(b)(1); instead, the corporate income is taxed pro rata to the shareholders. 26 U.S.C. § 1372(a). Concomitantly, when a Subchapter S corporation suffers a net operating loss, subsections 1374(a) and (d)(1) provide that the loss is passed through to the shareholders, each of whom may use his share of the loss to offset other personal income. There are, however, limitations upon the amount of the net operating loss deductible by the shareholder. Under § 1374(c)(2), a shareholder's deductible share of the Subchapter S corporation's net operating loss is limited to (A) his adjusted basis in his Subchapter S stock and (B) the adjusted basis of any indebtedness of the corporation to him.
Early in 1967 the taxpayers' accountant informed them that Albuquerque's anticipated losses could well exceed their combined basis of $13,000 in their Albuquerque stock. Accordingly, he advised them to consider taking measures that would increase their basis in Albuquerque's stock or indebtedness so that they could avail themselves of the deduction for that corporation's net operating losses. They settled upon the following plan, which was subsequently effectuated: (1) Lubbock surrendered the $110,000 worth of Albuquerque notes to Albuquerque and marked them "paid" as of January 31, 1967; (2) the taxpayers substituted their personal demand note to Lubbock in the amount of $110,000 at six percent interest for the notes surrendered by Lubbock to Albuquerque; and (3) Albuquerque issued to the taxpayers a demand note in the amount of $110,000 at six percent interest. 1
At the time of the transaction, no party either advanced or received any funds. Lubbock regularly accrued and reported for income tax purposes the interest due on the taxpayers' note. In April of 1968 the taxpayers made a payment to Lubbock for interest due on their note. In the same month Albuquerque, which had never made any payments of either principal or interest on its notes to Lubbock prior to their cancellation, paid Lubbock $6,980. This sum represented the total amount of interest which had accrued on the notes as of January 31, 1967, the cancellation date. In 1969 the taxpayers made a second payment of interest to Lubbock.
Pursuant to § 1376(b), when a subchapter S shareholder takes a deduction for his corporation's net operating loss, the shareholder's basis in the corporation's stock is reduced by the amount of the deduction. By the end of 1968 the taxpayers had exhausted their bases in their Albuquerque stock. In the fiscal year ending April 30, 1969 Albuquerque had a net operating loss of $13,054.74; on their income tax returns for that year the taxpayers each took a deduction of $6,527.37 for his share of this loss.
On March 6, 1970, after the close of the tax year in issue, the taxpayers made a final payment of interest to Lubbock; they paid in full their note to Lubbock on March 27, 1970. At the time this suit was instituted, Albuquerque had made no payments to the taxpayers of either principal or interest on account of its note to them.
On the theory that this loss was not deductible by the taxpayers because in 1969 they had no basis in any stock or indebtedness of Albuquerque as required by Section 1374(c)(2), the Commissioner disallowed these deductions and assessed deficiencies. In the Tax Court the taxpayers argued that the 1967 exchange of papers had given them a basis of $110,000 in the Albuquerque note to them, thus entitling them to deductions for their share of Albuquerque's 1969 net operating loss. The Tax Court analogized the 1967 transaction to a shareholder's guaranty of his Subchapter S corporation's indebtedness and found that it should be treated similarly for purposes of § 1374(c)(2). Relying on cases holding that no basis-giving indebtedness within the meaning of § 1374(c) (2)(B) arises where a shareholder merely guarantees the debt of a Subchapter S corporation, the court found for the Commissioner. We agree with the reasoning of the court below.
In section 1374(c)(2)(B) the term "adjusted basis of any indebtedness of the corporation to the shareholder" is not specifically defined in relation to that section; however, the report of the Senate Committee on Finance accompanying the Subchapter S legislation indicates that the purpose of the section is to limit the amount of a Subchapter S corporation's net operating loss that may be deducted by a shareholder to the "adjusted basis of the shareholder's investment in the corporation." S.Rep. No. 1983, 85th Cong., 2d Sess., U.S.Code Cong. & Admin.News, p. 5008 (1958). Construing this language of the committee report in Perry v. Commissioner, 54 T.C. 1293, 1296, aff'd per curiam 71-2 U.S.T.C., P 9502 (8th Cir. 1971), the Tax Court said:
. . . (I)t appears to us that, given its most familiar meaning, (citation omitted), the use of the word "investment" reveals an intent, on the part of the committee, to limit the applicability of section 1374(c)(2)(B) to the actual economic outlay of the shareholder in question.
The rule which we reach by this interpretation is no more than a restatement of the well-settled maxim which requires that "Before any deduction is allowable there must have occurred some transaction which when fully consummated left the taxpayer poorer in a material sense." (Footnote omitted; emphasis added)
Similarly, in Wheat v. United States, 353 F.Supp. 720, 722 (S.D....
To continue reading
Request your trial
-
Norfolk Southern Corp. v. Comm'r of Internal Revenue
...supra; Estate of Emerson v. Commissioner, 67 T.C. 612, 617–618 (1977); Underwood v. Commissioner, 63 T.C. 468 (1975), affd. 535 F.2d 309 (5th Cir.1976). The evidence in the instant cases does not support such a finding. There is no evidence that any of respondent's agents made false represe......
-
Fox v. Comm'r of Internal Revenue (In re Estate of Leavitt )
...* * * »Raynor v. Commissioner, 50 T.C. 762, 770-771 (1968). †See also Putnam v. Commissioner, 352 U.S. 82 (1956); Underwood v. Commissioner, 535 F.2d 309 (5th Cir. 1976), affg. 63 T.C. 468 (1975); Perry v. Commissioner, 47 T.C. 159, affd. 392 F.2d 458 (8th Cir. 1968); Wheat v. United States......
-
Reser v. C.I.R., 96-60393
...(finding grossly erroneous items where there was no basis in law for the deductions).23 26 U.S.C. § 1366(a)(1994); Underwood v. Commissioner, 535 F.2d 309, 310 (5th Cir.1976).24 26 U.S.C. § 1366(a)(1994); Underwood, 535 F.2d at 310.25 26 U.S.C. § 1366(d)(1994).26 Harris v. United States, 90......
-
Ivison v. Internal Revenue Serv. (In re Ivison)
...194. 125. Id. at 182; Defs.' Ex. 24. 126. See Defs.' Exs. 25, 26. 127. See Pls.' Exs. 25, 26. 128. 26 U.S.C. § 1366; Underwood v. C.I.R., 535 F.2d 309, 310 (5th Cir. 1976). 129. 26 U.S.C. § 1366. 130. 26 U.S.C. § 1366(d)(1)(A), (B). 131. 353 F. Supp. 720 (S.D. Tex. 1973). 132. Wheat, 353 F.......
-
Economic outlay revisited.
...Technical Resource Panel. For more information about this article, contact Mr. Porcaro at gporcaro@opacpa.com. (1) See, e.g., Underwood, 535 F.2d 309 (5th Cir. 1976), aff'g 63 T.C. 468 (1975); Estate of Bean, 268 F.3d 553 (8th Cir. 2001); Reser, 112 F.3d 1258 (5th Cir. 1997); Estate of Leav......
-
Federal Taxation - Dustin M. Covello, Jacquelyn L. Griffin, and Svetoslav S. Minkov
...1985) (interpreting previous version of statute). 43. Rose, 2008 WL 1823309, at *7 (quoting Selfe, 778 F.2d at 772; Underwood v. Comm'r, 535 F.2d 309, 311 (5th Cir. 1976)). 44. Id. at *7-8. 45. 535 F.2d 309 (5th Cir. 1976). 46. See id. at 310. 47. Id. at 311-13. 48. Id. at 313. 49. Rose, 20......
-
The story of basis.
...Sec. 752 provides partners with outside basis for all debts of the partnership. (28) See, e.g., Raynor, 50 T.C. 762 (196S); Underwood, 535 F.2d 309 (5th Cir. (29) Rev. Rul. 81-187, 1981-2 C.B. 167. But see Perachi, 143 F.3d 487 (9th Cir. 1998), in which the court allowed the shareholder to ......
-
S corporation current developments: S corporation eligibility and elections, operations, reorganizations and proposed legislation.
...W. Shaver, Jr., TC Memo 1993-619. (23)IRS Letter Ruling (TAM) 9403003 (9/29/93). (24)Morris G. Underwood, 63 TC 468 (1975), aff'd, 535 F2d 309 (5th Cir. 1976)(38 AFTR2d 76-5476, 76-2 USTC [paragraph]9557). (25)Donald S. Gilday, TC Memo 1982-242. (26)Rev. Rul. 75-144, 1975-1 CB 277. (27)IRS ......