Fox v. Comm'r of Internal Revenue (In re Estate of Leavitt )
| Decision Date | 10 February 1988 |
| Docket Number | 36454-84,36453-84,Docket Nos. 32041-84,36455-84. |
| Citation | 90 T.C. No. 16,90 T.C. 206 |
| Parties | ESTATE OF DANIEL LEAVITT, DECEASED, CHARLES D. FOX, III, EXECUTOR, AND ESTATE OF EVELYN M. LEAVITT, DECEASED, CHARLES D. FOX, III, EXECUTOR, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Ps were shareholders in V, an electing small business corporation under subchapter S of the Internal Revenue Code. Ps guaranteed a loan issued by a bank to V. At the time the loan was made, V's liabilities exceeded its assets, and V was unable to meet its cash flow requirements. The loan was issued by the bank only because of Ps' financial strength. However, all payments of principal and interest on the loan were made by V.
HELD, absent an economic outlay by Ps, Ps' guarantees of the loan do not increase their basis in their stock in V. Brown v. Commissioner, 706 F.2d 755 (6th Cir. 1983), affg. T.C. Memo. 1981-608, and Calcutt v. Commissioner, 84 T.C. 716 (1985), followed. Selfe v. United States, 778 F.2d 769 (11th Cir. 1985), explained. In re Lane, 742 F.2d 1311 (11th Cir. 1984), distinguished. Dianne E. H. Wilcox, for the petitioners.
Stephen M. Friedberg, for the respondent.
Respondent determined deficiencies in petitioners' Federal income tax as follows:
+-------------------------------------+
¦Docket No.¦Tax year ended—¦Deficiency¦
+----------+---------------+----------¦
¦32041-84 ¦Dec. 31, 1979 ¦$4,767.77 ¦
+----------+---------------+----------¦
¦ ¦Dec. 31, 1980 ¦1,577.06 ¦
+----------+---------------+----------¦
¦36453-84 ¦Dec. 31, 1979 ¦3,031.29 ¦
+----------+---------------+----------¦
¦ ¦Dec. 31, 1980 ¦16,472.46 ¦
+----------+---------------+----------¦
¦ ¦Dec. 31, 1981 ¦13,919.88 ¦
+----------+---------------+----------¦
¦36454-84 ¦June 30, 1980 ¦901.00 ¦
+----------+---------------+----------¦
¦ ¦June 30, 1981 ¦1,041.00 ¦
+----------+---------------+----------¦
¦ ¦June 30, 1982 ¦1,252.00 ¦
+----------+---------------+----------¦
¦36455-84 ¦Dec. 31, 1979 ¦1,320.98 ¦
+----------+---------------+----------¦
¦ ¦Dec. 31, 1980 ¦1,495.88 ¦
+----------+---------------+----------¦
¦ ¦Dec. 31, 1981 ¦2,298.86 ¦
+-------------------------------------+
These cases were consolidated for trial, briefing and opinion pursuant to Rule 141(a). 2 After concessions and stipulations,3 the only issue for decision is whether a shareholder's guarantee of the debt of an electing small business corporation under subchapter S of the Internal Revenue Code increases the shareholder's basis in his stock in the corporation.
That a shareholder-guaranteed corporate debt can be characterized for Federal tax purposes as a capital contribution is hardly a novel legal theory. This legal theory has been considered in at least 20 opinions. 2 Almost invariably, these opinions consider traditional debt-equity principles in determining whether to characterize a guaranteed debt as a capital contribution. 3 Despite this heavy weight of authority, the majority opinion ‘decline»s† to adopt traditional debt-equity principles in this case. ‘ Majority slip op. at 15. The majority opinion bases its declination to apply traditional debt-equity principles on its erroneous interpretation of Blum v. Commissioner, 59 T.C. 436 (1972), and on its unsound refusal to follow Selfe v. United States, 778 F.2d 769 (11th Cir. 1985).
The majority opinion states that in Blum
»the Tax Court† declined to decide the issue as to the applicability of debt-equity principles because the taxpayer had failed his burden of proving that the bank in substance had loaned the funds to the taxpayer and not to the corporation. Blum v. Commissioner, 59 T.C. at 439, n.4. »Majority opinion at p. 215.†
The majority opinion misstates the ty opinion misstates the holding in Blum wherein the Court stated:
As we stated in Santa Anita Consolidated, Inc. »v. Commissioner, 50 T.C. 536, 550 (1968), ‘Whether such debt guaranteed debt is to be treated as an indirect capital contribution must be resolved by an investigation of the facts in light of traditional debt-equity principles.‘ In the present fully stipulated case, after applying many of those traditional principles, we find that petitioner simply has not carried his burden of proof and has not convinced this Court that the guaranteed loans should properly be characterized as equity investments. Bracketed phrase, ‘guaranteed debt,‘ in original.†>>>>>>
Contrary to the majority opinion, the Tax Court did not decline to apply traditional debt- equity principles because the taxpayer failed in his burden of proof, but rather applied traditional debt-equity principles to determine that the taxpayer failed in his burden of proof. The distinction is more than merely semantical. As will be seen below, petitioners herein have carried their burden of proof. Accordingly, a proper interpretation of Blum and a proper application of traditional debt- equity principles, as mandated by Blum, would lead to a result contrary to the result reached by the majority. 4
To determine the amount of the section 1374(c)(2) limitation each petitioner is entitled to, I would look to state law to determine what each petitioner's legal rights and obligations are as a result of their guaranty of the $300,000 loan. See Burnet v. Harmel, 287 U.S. 103, 110 (1932). (‘The state law creates legal interests but the federal statute determines when and how they shall be taxed.‘) The guaranty signed by petitioners states that it ‘shall be governed and construed in accordance with the laws of the State of Virginia. ‘ Accordingly, I would look to Virginia State law.
Each of the shareholder/guarantors bound themselves to jointly and severally guarantee the $300,000 indebtedness of VAFLA to the Bank of Virginia. Although the shareholder/guarantors may have owned various percentages of VAFLA, their obligations arising from their guarantees were identical. 21 See Cooper v. Greenberg, 191 Va. 495, 61 S.E.2d 875, 877 (1950). Pursuant to the guarantees, the Bank of Virginia could proceed against any one of the shareholder/guarantors for the full amount of the indebtedness without first attempting to collect from VAFLA. A shareholder/guarantor required to pay the indebtedness could proceed against the other shareholder/guarantors pursuant to the equitable principle of contribution ‘that where two or more persons are subject to a common burden it shall be borne equally, since the law implies a contract between them to contribute ratably towards the discharge of the obligation.‘ Wiley N. Jackson Co. v. City of Norfolk, 197 Va. 62, 87 S.E.2d 781, 78 4 (1955).
All the facts have been stipulated. The stipulations of fact and attached exhibits are incorporated herein by this reference.
At the time the petitions in these cases were filed, Charles D. Fox, III, Anthony D. Cuzzocrea and Marjorie F. Cuzzocrea resided in Roanoke, Virginia. 4 Daniel and Evelyn Leavitt, whose estates are petitioners in docket No. 32041-84, filed a joint Federal income tax return for the taxable year 1979. 5 Anthony D. Cuzzocrea and Marjorie F. Cuzzocrea filed joint Federal income tax returns for the taxable years 1979, 1980 and 1981.
VAFLA Corporation (hereinafter referred to as the corporation), was an electing small business corporation under subchapter S during the years in issue and was incorporated in February, 1979, to acquire and operate the Six-Gun Territory Amusement Park near Tampa, Florida. The initial issue of the corporation's capital stock took place in March, 1979, and consisted of 100,000 shares. Daniel Leavitt and Anthony D. Cuzzocrea each paid $10,000 cash for their shares on or before September 30, 1979.
The first taxable year of the corporation consisted of seven months and ended on September 30, 1979. As of September 30, 1979, the corporation had suffered a net operating loss of $265,566.47 and had a retained earnings deficit of $345,370.20. During its second taxable year ending September 30, 1980, the corporation suffered a net operating loss of $482,181.22 and had a retained earnings deficit of $1,093,383.56. During its third taxable year ending September 30, 1981, the corporation suffered a net operating loss of $475,175.70 and had a retained earnings deficit of $1,908,680.22.
From August 2, 1979, through August 27, 1979, Anthony D. Cuzzocrea and Daniel Leavitt, as well as other shareholders, signed guarantee agreements whereby each agreed to be jointly and severally liable for all indebtedness of the corporation to the Bank of Virginia. All the guarantees to the Bank of Virginia were unlimited except the guarantee of Anthony D. Cuzzocrea which was limited to $300,000.
The corporation borrowed $300,000 from the Bank of Virginia for which it issued a promissory note to the bank dated September 12, 1979. The purpose of the loan was to fund VAFLA's existing and anticipated operating deficits.
At the time the loan was made, the corporation's liabilities exceeded its assets, and the corporation had so little available cash that it could not meet its cash flow requirements. Virtually all of the corporation's assets were encumbered as collateral for a purchase money indebtedness of approximately $1 million to National Service Industries, Inc. In processing the loan, the Bank of Virginia was provided a statement of income for the corporation for its first three months of operation during which the corporation experienced a loss of $142,410.16, resulting in a negative net worth of $82,410.16 as of May 31, 1979.
Seven of the corporation's shareholders agreed to guarantee the $300,000 loan personally. According to the financial statements submitted to the bank, these shareholders had an aggregate...
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