Bolding v. C.I.R., 96-60112

• Decision Date: 18 July 1997
• Docket Number: No. 96-60112,96-60112
• Citation: 117 F.3d 270
• Parties: -5481, 97-2 USTC P 50,554 Dennis E. BOLDING; Dixie R. Bolding, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 270

117 F.3d 270

80 A.F.T.R.2d 97-5481, 97-2 USTC P 50,554

Dennis E. BOLDING; Dixie R. Bolding, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 96-60112.

United States Court of Appeals, Fifth Circuit.

July 18, 1997.

Farley P. Katz, Charles J. Muller, III, Anthony E. Rebollo, III, Wells, Pinckney & McHugh, San Antonio, TX, for Petitioners-Appellants.

Gary R. Allen, Sara Smith Holderness, Loretta Argrett, Asst. Atty. Gen., Richard Bradshaw Farber, U.S. Department of Justice, Tax Division, Appellate Section, Washington, DC, Charles Casazza, Clerk, U.S. Tax Court, Washington, DC, Stuart L. Brown, Chief Counsel, Internal Revenue Service, Washington, DC, for Respondent-Appellee.

Petition for Review of a Decision of the United States Tax Court.

Before REAVLEY, GARWOOD and BENAVIDES, Circuit Judges.

GARWOOD, Circuit Judge:

This appeal involves disputed deficiencies in the income tax returns of appellants Dennis and Dixie Bolding, husband and wife, for the taxable years 1988, 1989, and 1990. The Boldings filed a petition contesting the deficiencies in the United States Tax Court. The court entered a memorandum opinion, unofficially reported at 70 T.C. (CCH) 110, rendering a decision in favor of the Commissioner of Internal Revenue (Commissioner). We reverse.

Facts and Proceedings Below

In the late 1970s, Dennis Bolding (Taxpayer) ¹ began a cattle ranch operation, breeding and selling cattle for the meat market. Taxpayer was advised by his accountant that he should conduct his cattle ranching operation through a corporation for liability purposes. Accordingly, in August 1983 Taxpayer formed Three Forks Land & Cattle Company (Three Forks), a Texas corporation which periodically engaged in both the commercial and the registered cattle businesses. ² The corporation was structured as a Subchapter S corporation, and at all times was wholly owned by Taxpayer, who was its president.

Prior to 1990, Taxpayer had lent approximately $500,000 to Three Forks, money which he had obtained from the sale of his prior businesses, including a beer distributorship and a ranch. Although these loans were recorded in Three Forks' books and records as loans from a shareholder, no promissory notes for these loans were prepared or executed. Sometime during 1990, Taxpayer and his accountant realized that Three Forks would not be able to repay Taxpayer the money he had lent it. As a result, the indebtedness for the money previously advanced as a loan to Three Forks was contributed by Taxpayer to the capital of the corporation.

At the beginning of 1990, Taxpayer leased a ranch known as the Hopper Ranch. He needed additional funds to purchase cattle to stock his ranching operation. He contacted the Citizens State Bank of Lometa in Lometa, Texas (Bank), and explained that he wanted a loan to fund his cattle operation. The Bank required Taxpayer to submit a personal financial statement and a proposed operating statement showing the planned use of the funds. Pursuant to the Bank's request, Taxpayer submitted his personal financial statement (showing a net worth in excess of $2,000,000, with over $200,000 cash on hand) and proposed operating statement, explaining the need for and his proposed use of the funds. The proposed operating statement indicated that Taxpayer wanted the loan to fund a "cow-calf operation" in which he would purchase 400 cows and 20 bulls and graze them on 4,800 acres. He asked for a line of credit from the Bank in the amount of $250,000. No financial information with respect to Three Forks was asked for or submitted.

The Bank approved the $250,000 line of credit and prepared a promissory note, which Taxpayer signed, naming "Dennis E. Bolding d/b/a Three Forks Land & Cattle Co." as the maker-borrower. The Bank also required the filing of a security agreement and a UCC-1 financing statement. The security agreement was signed "Dennis E. Bolding d/b/a Three Forks Land & Cattle Co.," and provided the Bank with a security interest in the cows and bulls that were to be acquired with the funds borrowed under the line of credit. The UCC-1 statement, however, was signed by Taxpayer simply as "Dennis E. Bolding."

Taxpayer believed that he was borrowing the funds in his personal capacity and not on behalf of Three Forks. Also, the Bank indicated that it was making the loan to Taxpayer alone and based upon his personal credit. None of the loan documents prepared by the Bank was prepared for Three Forks as debtor, nor were any signed by anyone on behalf of the corporation. ³

The funds were disbursed directly from the Bank to Three Forks' corporate account and were used by Three Forks to purchase cattle. ⁴ Principal and interest payments were made to the Bank from time to time with respect to the $250,000 line of credit. Such principal and interest payments to the Bank were made by checks drawn on Three Forks' account.

By the end of 1990, the total amount outstanding on the line of credit, net of all repayments, was $223,000. The line of credit was rolled over into later years, after its initial maturity, but ultimately went into default in March 1994 with an outstanding balance. The Bank sued Taxpayer for repayment on the outstanding balance of the loan; no action was taken against Three Forks.

Three Forks reported an ordinary loss for its 1990 year of $93,769. Taxpayer deducted, among other things, that amount on his 1990 income tax return as his share of the S corporation's loss. ⁵ Also, Taxpayer deducted a carryover loss from the corporation's 1989 tax return in the amount of $25,454, for a total loss of $119,223. After reporting a capital gain of $19,681 from the corporation in the corporation's 1990 tax return, the net loss from the corporation claimed in Taxpayer's 1990 tax return was $99,542. The corporation's loss deducted on Taxpayer's 1990 tax return created a net operating loss for that year and a carryback to the 1988 year in the amount of $62,170. Petitioner claimed an additional net operating loss carryback to 1988 from 1989 for $15,344.

The Commissioner disagreed with Taxpayer's deductions, and issued a statutory notice of deficiency in July 1993. The Commissioner disallowed the entire $99,542 net loss claim for 1990 on the grounds that Taxpayer had insufficient basis in Three Forks' stock to support such an allowance. The Commissioner also reduced the net operating loss carrybacks claimed to Taxpayer's 1988 tax return in the aggregate amount of $64,136.

Taxpayer and his wife filed a petition in the Tax Court seeking redetermination of the deficiencies set forth in the notice. After settlement by the parties, the only issue presented to the Tax Court was whether the Commissioner correctly determined that Taxpayer was not entitled to deduct on his federal income tax return for 1990 the $99,542 net operating loss incurred by Three Forks. Although corporate losses deducted prior to 1990 had exhausted his adjusted basis in Three Forks, Taxpayer maintained that his basis in the corporation increased during 1990 as a result of the $250,000 line of credit obtained from the Bank. According to Taxpayer, he, solely in his individual capacity, borrowed the funds under the $250,000 credit from the Bank and, in turn, he lent those funds to Three Forks. Taxpayer argued that his basis in Three Forks at the end of 1990 equaled the outstanding balance on this line of credit.

The Commissioner, on the other hand, maintained that Three Forks, rather than Taxpayer, was the true borrower from the Bank with respect to the funds advanced under the $250,000 line of credit so that consequently, there was no loan by Taxpayer to the corporation with respect to that line of credit. Accordingly, the Commissioner concluded that Taxpayer's basis in the corporation did not increase as a result of the funds advanced by the Bank on the $250,000 loan and that Taxpayer, therefore, was not entitled to deduct any of the corporation's $99,542 net operating loss on his individual return for 1990.

Following a one-day trial, the Tax Court entered a memorandum opinion holding that Taxpayer was not entitled to deduct the corporation's net operating loss. The Tax Court found as a fact that Taxpayer, rather than Three Forks, was the true borrower from the Bank with respect to the funds disbursed under the $250,000 line of credit. The court, however, ultimately agreed with the Commissioner that Taxpayer did not have sufficient basis in Three Forks' stock or debt to entitle him to deduct any of the corporation's $99,542 net operating loss. According to the court, the evidence showed that the funds from the loan were deposited sometimes directly from the Bank to Three Forks' accounts, and sometimes to Taxpayer's personal account, and Taxpayer had failed to show how much went to Three Forks. ⁶ After recomputation of the deficiency, the Tax Court entered its decision determining deficiencies in Taxpayer's federal income tax for the years 1988, 1989, and 1990 in the amounts of $17,896, $103, and $5,091, respectively. From this decision, Taxpayer now appeals.

Discussion

The key issue in this case centers around the nature of the $250,000 line of credit. If, as the Commissioner contends, the loan was one from the Bank to Three Forks, Taxpayer could not have invested the proceeds of the loan in the corporation, and thus his basis in the corporation would not have increased and would not suffice to allow him to deduct its operating losses. On the other hand, if the line of credit was actually a loan from the Bank to Taxpayer, who then invested the funds in or loaned them to his corporation, the Taxpayer's basis in the corporation would be correspondingly increased and sufficient to allow him to deduct its referenced losses. See In re Breit, 460 F.Supp. 873, 875 (E.D.Va.1978). In other words, we must determine whether the $250,000 line of credit was a loan from the Bank to Three Forks or whether it was a loan to...