Lane, In re

• Citation: 742 F.2d 1311
• Decision Date: 27 September 1984
• Docket Number: No. 83-7451,83-7451
• Parties: 84-2 USTC P 9817 In re James A. LANE, Bankrupt. Frances B. LANE and James M. Gaines, as Trustee of the Bankrupt Estate of James A. Lane, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (11th Circuit)

Page 1311

742 F.2d 1311

84-2 USTC P 9817

In re James A. LANE, Bankrupt.

Frances B. LANE and James M. Gaines, as Trustee of the Bankrupt Estate of James A. Lane, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.

No. 83-7451.

United States Court of Appeals, Eleventh Circuit.

Sept. 27, 1984.

Ben L. Zarzaur, Harry B. Maring, Birmingham, Ala., for plaintiffs-appellants.

Frank W. Donaldson, U.S. Atty., Caryl P. Privett, Asst. U.S. Atty., Birmingham, Ala., Glenn L. Archer, Jr., Asst. Atty. Gen., Michael L. Paup, Chief Appellate Section, Carleton D. Powell, Melvin E. Clark, Jr., Dept. of Justice, Tax Division, Washington, D.C., for defendant-appellee.

Appeal from the United States District Court for the Northern District of Alabama.

Before KRAVITCH and HATCHETT, Circuit Judges, and MORGAN, Senior Circuit Judge.

HATCHETT, Circuit Judge:

In this tax refund case, we decide that advances from a shareholder-taxpayer to several corporations did not constitute debt, deductible under 26 U.S.C.A. Sec. 166 (West 1978). We affirm.

Background

James A. Lane, the taxpayer, is involved in the real estate business. In 1961, Lane acquired the Parliament House property in Birmingham, Alabama, and operated it as a hotel until March, 1972. In 1972, Lane sold the hotel netting approximately $1 million. Due to this large amount of income, Lane paid taxes of over $321,000.

Following sale of the Parliament House, Lane became involved in several other hotel operations. The three hotels relevant to this case are (1) The Campus Inn, at Auburn, Alabama, (2) The Southern Peabody, in Memphis, Tennessee, and (3) The Russell Erskine, in Huntsville, Alabama. Lane established these hotels as Subchapter S corporations with himself as controlling stockholder. Although Lane's percentage interest in several of the hotels decreased somewhat, he at all times retained over 40% stock interest in each of the three hotels.

The three hotels were not successful business ventures. To satisfy the hotels' need for funds, Lane advanced several hundred thousand dollars to the corporations and obtained funds from several institutional lenders, personally guarantying these institutional loans.

In 1975, when the three corporations failed, Lane's direct advances to the corporations had not been repaid. In addition, Lane incurred further losses when he was required to satisfy, as guarantor, the corporate obligations to the institutional lenders. In 1975, Lane filed an individual bankruptcy proceeding in the United States Bankruptcy Court, Northern District of Alabama, Southern Division. In 1979, Lane filed an amended income tax return for the year 1975 and claimed that he was entitled to bad debt deductions because of the money owed to him from the failed corporations. Lane sought to have these deductions against income carried back to 1972, thus, entitling him to a refund of $321,573 plus interest and costs for federal income taxes paid in 1972.

Following the denial by the Internal Revenue Service of Lane's claims, Frances B. Lane, the wife of James A. Lane, and James M. Gaines, as trustees of the bankrupt estate of James A. Lane, filed an adversary proceeding in United States Bankruptcy Court on September 2, 1980, for the refund of taxes allegedly illegally, erroneously, and excessively collected. This action was subsequently transferred from the Bankruptcy Court to the United States District Court for the Northern District of Alabama, Southern Division. The only issue before the district court was whether the amounts giving rise to the claim of a deduction constituted debt or equity. As the district court stated, "If the court determines that the amounts represent debt, the defendant has agreed to stipulate that the amounts represent business debts and that the claims for refund were timely filed and are due to be granted."

The district court held that the amounts advanced to, or on behalf of, the corporations did not constitute debt, but were equity in the corporations, and were not deductible. Without the bad debt deduction, plaintiffs, Frances B. Lane and James A. Gaines, the trustees of the bankrupt estate of James A. Lane, were not entitled to the claimed refund of $321,573 for taxes paid in 1972.

Discussion

The issue of whether advances made by a shareholder to a corporation constitute debt or equity is one faced by the courts many times. A taxpayer is entitled to take as a deduction any debt which becomes worthless in that taxable year. 26 U.S.C.A. Sec. 166(a)(1). ¹ The regulations clearly state that a contribution to capital cannot be considered a debt for purposes of section 166. 26 C.F.R. Sec. 1.166-1(c) (1983). ² "The question of whether the advances from [Lane to the three corporations] constitute a loan or a contribution to capital depends on whether the advances are debt (loans) or equity (contributions to capital)." Stinnett's Pontiac Service, Inc. v. C.I.R., 730 F.2d 634, 638 (11th Cir.1984).

The Fifth Circuit in Slappey Drive Ind. Park v. United States, 561 F.2d 572 (5th Cir.1977), sought to clarify the differences between debt and equity. "Articulating the essential difference between the two types of arrangement that Congress treated so differently is no easy task. Generally, shareholders place their money 'at the risk of the business' while lenders seek a more reliable return." Slappey, 561 F.2d at 581. In order for an advance of funds to be considered a debt rather than equity, the courts have stressed that a reasonable expectation of repayment must exist which does not depend solely on the success of the borrower's business. American Processing and Sales Co. v. United States, 371 F.2d 842, 856, 178 Ct.Cl. 353 (1967). The courts have devised guidelines to facilitate a determination of whether advances to a corporation constitute debt or equity.

Decisions in this Circuit have stressed at least thirteen factors which merit consideration in determining this issue. They are:

(1) the names given to the certificates evidencing the indebtedness;

(2) the presence or absence of a fixed maturity date;

(3) the source of payments;

(4) the right to enforce payment of principal and interest;

(5) participation in management flowing as a result (6) the status of the contribution in relation to regular corporate creditors;

(7) the intent of the parties;

(8) 'thin' or adequate capitalization;

(9) identity of interest between creditor and stockholder;

(10) source of interest payments;

(11) the ability of the corporation to obtain loans from outside lending institutions;

(12) the extent to which the advance was used to acquire capital assets; and

(13) the failure of the debtor to repay on the due date or to seek a postponement.

Estate of Mixon v. United States, 464 F.2d 394, 402 (5th Cir.1972).

The courts have stressed that these guidelines are not rigid rules mandating a particular conclusion when the court finds certain facts. It is our job not simply to count the factors applicable in a case, but, instead, to evaluate them. Tyler v. Tomlinson, 414 F.2d 844, 848 (5th Cir.1969). "We review the relevant [factors] well aware that '[e]ach case turns on its own factors; differing circumstances may bring different factors to the fore.' " Jones v. United States, 659 F.2d 618, 622 (5th Cir. Unit B 1981) (quoting Slappey, 561 F.2d at 581). Although our courts have devised the above-mentioned guidelines as an aid in determining whether advances constitute debt or equity, we must bear in mind the dictates set forth in Tyler:

As we have said elsewhere in situations requiring the quest for a solution among myriad criteria: 'We think that the tests are, at most, helpful factors to be considered, and not fiats to be bound by. We disapprove of rubricating such "tests" into talismans of magical power. Georgia Southern and F. Ry. Co. v. Atlantic Coast Line R. Co., 5 Cir.1967, 373 F.2d 493, 498, cert. denied, 389 U.S. 851, 88 S.Ct. 69, 19 L.Ed.2d 120.

Tyler, 414 F.2d at 848.

The district court, in this case, examined those factors it deemed relevant and determined that Lane's advances to the corporation constituted contributions to capital rather than loans and denied Lane's claim for a refund of taxes paid in 1972. "The issue is primarily one of law. We must uphold the district court's findings of basic facts unless clearly erroneous, but the ultimate characterization of the transactions as debt or equity receives no such protection." Slappey, 561 F.2d at 582 n. 17. "This evaluation presents primarily a question of law, and a district court's determination of the issue is thus subject to a de novo review by this court." Estate of Mixon, 464 F.2d at 402-03 (footnote omitted). We now review the debt-equity question, examining the facts of this case in light of those Mixon factors which are pertinent, relevant, and significant.

(1) The Name Given to the Certificate.

"The thrust of this factor is that the court will look to the type of certificate used by the parties in considering the debt-equity question." Estate of Mixon, 464 F.2d at 403. In this case, the vast majority of certificates used by the parties were notes. "[T]he issuance of a bond, debenture, or note is indicative of a bona fide indebtedness." Estate of Mixon, 464 F.2d at 403. Although the form of the instrument may be relevant, see Liflans Corporation v. United States, 390 F.2d 965, 969, 182 Ct.Cl. 825 (1968), "[t]he decisive factor is not what the payments are called but what, in fact, they are, and that depends upon the real intention of the parties." Byerlite Corporation v. Williams, 286 F.2d 285, 290 (6th Cir.1960). The mere fact that Lane set forth the advances to the corporations in the form of notes is not of significant importance in our determination of whether the advances constituted debt or equity. "While the issuance of a note may evidence a bona fide indebtedness, an unsecured note due on demand with no specific maturity date, and no payments is...