Abdalla v. Comm'r of Internal Revenue
| Decision Date | 13 February 1978 |
| Docket Number | Docket No. 1783-74. |
| Citation | 69 T.C. 697 |
| Parties | JACOB ABDALLA and MARY T. ABDALLA, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Held: Petitioner is entitled to a deduction for his pro rata share of two subch. S corporations' net operating losses. Because petitioner's stock basis and basis of indebtedness became worthless as of Oct. 26, 1966, his share of such losses is computed for that part of the corporations' taxable year ending Oct. 25, 1966. Held, further, interest payments made in connection with a bad debt are colored thereby, giving rise to a sec. 166 bad debt loss. Held, further, petitioner's basis for the purpose of computing gain realized on the liquidation of two other corporations is not increased due to a debt assumed thereon when such assumption does not increase the amount of his outstanding liabilities. Held, further, neither is such gain reduced by the amount of deficiencies in Federal income tax owed by these two corporations that he, as transferee thereof, is required to pay. H. Book Hopkins, for the petitioners.
Eddy M. Quijano, for the respondent.
Respondent determined a deficiency in petitioners' Federal income tax for the calendar year 1968 in the amount of $143,895.95. Due to concessions made by the parties, four issues remain for our determination: (1) Is shareholder petitioner entitled to a deduction for a portion of the net operating losses of the two subchapter S corporations as calculated at their year ended January 31, 1967, to the extent of his stock basis and basis of indebtedness therein; (2) is petitioner entitled to a section 163 interest deduction in 1968 by reason of payments on two notes of a bankrupt corporation which petitioner had guaranteed in solido; (3) should the gain petitioner realized in liquidating two other corporations be reduced by the balance outstanding on a note executed by one of the bankrupt corporations which had been guaranteed by petitioner and the liquidated corporations; and (4) should that gain be further reduced by deficiencies owed by the liquidated corporations for which petitioner, as transferee of those corporations, is liable.
Some of the facts have been stipulated and are so found. The stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference.
Petitioners Jacob and Mary T. Abdalla, husband and wife, resided in Opelousas, La., at the time the petition herein was filed. Their joint Federal income tax return for the taxable year 1968 was filed with the District Director of Internal Revenue, Austin, Tex. Mary T. Abdalla is a party to this action only because she joined in the filing of this return and, accordingly, Jacob Abdalla will hereinafter be referred to as petitioner.
Petitioner was the owner of 100 percent of the outstanding stock of Abdalla's Furniture, Inc. (hereinafter Furniture), a corporation organized under the laws of the State of Louisiana on December 30, 1948. As of October 25, 1966, his stock basis and basis of indebtedness in Furniture were $100,000 and $141,500, respectively. In addition, petitioner owned 1,255 of the 1,275 shares outstanding of Abdalla's Downtown Furniture, Inc. (hereinafter Downtown Furniture), a corporation organized under the laws of the State of Louisiana on November 28, 1961. His stock basis therein was $125,500 as of October 25, 1966. Both corporations used a fiscal year which ended January 31 for purposes of calculating their Federal income tax liabilities.
Furniture and Downtown Furniture timely filed a properly executed election in accordance with the provisions of sections 1371 and 1372 to be considered subchapter S corporations. During the taxable year 1967 petitioner was the president and William O. Johnson, petitioner's certified public accountant, was the secretary-treasurer of both corporations.
Petitioner was also the president, principal shareholder, and chief executive officer of three realty corporations, Park Development Corp. (hereinafter Park), Vista Development Corp. (hereinafter Vista), and Park Vista Home Owners Corp., all organized and existing under the laws of the State of Louisiana.
Furniture and Downtown Furniture were adjudicated bankrupt on October 26, 1966. The parties stipulated that petitioner's stock basis and basis of indebtedness became completely worthless on that date. For the taxable year ended January 31, 1967, Furniture and Downtown Furniture had net operating losses of $255,825 and $208,170, respectively.
Prior to the adjudication of bankruptcy petitioner had endorsed two notes of Furniture in solido. In the taxable year 1968 he paid interest thereon totaling $10,650.36. One of these notes was also endorsed by Vista and Park. They each secured their endorsement of Furniture's liability by a promissory note payable to “bearer.” The promissory notes were, in turn, secured by attached collateral mortgages executed by the respective corporation.
On October 10, 1968, Park and Vista were liquidated. Petitioner computed the gain realized on liquidation without including in his basis the balance of $107,500 remaining on the Furniture note that had been endorsed by Park and Vista.
Petitioner included a deduction for the net operating losses of Furniture and Downtown Furniture in his individual tax return filed for his taxable year ended December 31, 1967. In his individual tax return filed for his taxable year ended December 31, 1968, he included a deduction for his personal net operating loss resulting from the flow through of these corporate losses carried forward to 1968.
OPINIONIssue 1. Net Operating Loss
The first issue before us is whether petitioner may deduct a portion of the net operating losses of the two subchapter S corporations, as calculated at their year ended January 31, 1967, as a net operating loss carryover for his taxable year ended December 31, 1968.
At the outset we note that respondent has stipulated that the filing or nonfiling of the U.S. Corporation Income Tax Returns (Form 1120-S) for the year ended January 31, 1967, is not an issue in this case. Indeed, no question has been raised with respect to the validity of the subchapter S elections of Furniture and Downtown Furniture for the taxable years involved. Finally, neither party has attached any significance to the fact of bankruptcy except to the extent that it established worthlessness.
Section 1374, I.R.C. 1954, allows a flow through of the net operating losses of subchapter S corporations to their shareholders. The flow through results in a deduction from the shareholder's gross income for the taxable year in which the corporation's taxable year ends in an amount equal to the shareholder's pro rata share of the net operating loss.1 A shareholder's pro rata share of that loss is based on his percentage of ownership and the number of days out of the taxable year during which he owned that percentage of the stock. Thus, if his ownership of stock is for less than the corporation's full taxable year his pro rata share is determined by cumulating the average daily losses of the corporation for his period of ownership. The deduction is limited to the adjusted basis of the shareholder's stock plus the adjusted basis of any debt the corporation owes to that shareholder, determined at the close of the corporation's taxable year or on the day before any disposition of the stock. Thus, within these prescribed limitations, petitioner, as a shareholder of two subchapter S corporations, may take advantage of their accrued net operating losses.
Petitioner asserts that his entire basis in his stock and indebtedness of these corporations was available for the purpose of calculating his share of the corporations' 1967 net operating losses and that his basis in said stock and debt should not be totally absorbed by basis adjustments arising due to any section 165 and 166 losses that emanate from the stipulated worthlessness as of October 26, 1966. He reaches this result by interpreting section 1016(a)(18) 2 to be a specific rule which excludes application of 1016(a)(1). We do not believe that the two paragraphs are mutually exclusive. Markham v. Cabell, 326 U.S. 404, 411 (1945).
Paragraph (a)(18) of section 1016 refers to section 1376 which adjusts the basis for amounts treated as dividends and for net operating losses which have passed through the corporation to the shareholder.3 These basis adjustments are necessary to integrate the unique treatment of shareholders of subchapter S corporations with the normal basis adjustments for shareholders of subchapter C corporations. It should be noted that sections 1376 and 1016(a)(18) were enacted concurrently. Section 1016(a)(1) applies to basis adjustments relating to capital loss.
To the extent applicable herein, which will be evident from the following discussions, we have no difficulty in finding paragraph 1016(a)(1) and (18) internally consistent.
Respondent contends that petitioner became entitled to section 165 worthless securities losses and a section 166 bad debt deduction on October 26, 1966, when the two corporations were adjudicated bankrupt. He concludes that such losses and deduction will absorb petitioner's basis in the two companies and leave nothing against which to offset petitioner's share of their net operating losses. A loss resulting from worthless securities is deductible as set forth in section 165(g). A debt that becomes worthless is deductible as set forth in section 166(d)(1).
It has been held that a loss within the framework of sections 165(g) and 166(d)(1) must be taken in the taxable year in which the worthlessness occurs. Boehm v. Commissioner, 326 U.S. 287 (194...
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