Maloof v. Commissioner, Docket No. 15211-02.
| Decision Date | 06 April 2005 |
| Docket Number | Docket No. 15211-02.,Docket No. 17951-03. |
| Citation | 89 T.C.M. 1022 |
| Parties | William H. Maloof v. Commissioner. |
| Court | U.S. Tax Court |
Donald J. O'Connor, for petitioner;
Anita A. Gill, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined deficiencies in petitioner's Federal income tax by disallowing operating losses sustained by an S corporation in which petitioner was the sole shareholder. After concessions, the sole issue before the Court is whether petitioner is entitled to increase his adjusted basis in the S corporation by $4 million, the amount of a loan a third party made to the S corporation. Resolving this issue depends on whether petitioner made an economic outlay regarding this loan to allow petitioner to increase his basis in the S corporation. We hold that he did not.
The parties have stipulated some facts. The stipulation of facts and the accompanying exhibits are incorporated by this reference and are so found.
Petitioner is the sole shareholder of several S corporations involved in the propane gas industry. One S corporation, Level Propane, Petroleum & Gases Co., an Ohio corporation (Level Propane),1 generated the losses petitioner claimed as passthrough deductions in this case. Level Propane provided propane gas to rural areas in Ohio initially, then expanded into neighboring States. At its peak, Level Propane provided propane gas and services to customers in 14 States and had about 600 employees who generated approximately $18 million in annual revenues.
Level Propane required increasingly large infusions of capital to sustain its growth. Level Propane's capital needs were funded initially with transfers from various S corporations in which petitioner owned all the shares. Eventually Level Propane obtained financing from commercial lenders. The specific loan involved here is a $4 million loan2 from Provident Bank (the bank) pursuant to a loan agreement dated July 29, 1993.
The $4 million loan consisted of three principal components, each collateralized differently. First, there was a $750,000 equipment note that was secured by equipment Level Propane would purchase with the loan proceeds. Second, there was a $2.5 million revolving term loan that was secured by petroleum tanks and supply contracts Level Propane owned. Third, there was a $750,000 demand loan that was secured by the inventory and accounts receivable of Level Propane. As additional collateral for the $4 million loan to Level Propane, petitioner pledged all the shares he owned of Level Propane and a $1 million life insurance policy on his life.
Level Propane made monthly interest payments on the $4 million loan through an account that Level Propane was required to maintain with the bank. Petitioner made no payments on the loan.
Level Propane defaulted on the loan and was forced into involuntary bankruptcy. At no time did the bank demand payment from petitioner individually or begin collection action against petitioner regarding the $4 million loan to Level Propane.
Level Propane generated substantial losses3 during the years at issue. Petitioner increased his basis in the stock of Level Propane by the amount of the $4 million loan to claim as passthrough deductions the net operating losses of Level Propane. Respondent determined that petitioner's basis in the stock of Level Propane did not increase by the amount of the $4 million loan to Level Propane because petitioner had never paid nor had he ever been called upon to pay any amount under the $4 million loan. Respondent consequently found that petitioner had insufficient basis against which to deduct any losses. Respondent mailed to petitioner notices of deficiency on June 28, 2002, and July 16, 2003, determining the following deficiencies:
Year Deficiency
1990 1$169,270
1991 77,709
1992 47,733
1993 351,162
1995 305,162
1996 1,939,205
1998 31,397
1999 50,870
2000 197,365
1 All dollar amounts are rounded to the nearest dollar
Petitioner timely filed a petition contesting respondent's determination, arguing that his basis was increased by the amount of the $4 million loan. We must therefore determine whether petitioner may increase his basis in the S corporation by the amount of the $4 million loan so petitioner may deduct passthrough operating losses of the S corporation.
OPINIONPetitioner and respondent differ on the effect of the $4 million loan the bank made to Level Propane. Petitioner argues that he is entitled to increase his basis in the stock of Level Propane by the amount of the loan for three reasons. First, petitioner argues that he is entitled to an increase in basis in Level Propane because he personally guaranteed the loan. Second, petitioner argues that he is entitled to increase his basis in Level Propane because he pledged stock to secure the loan. Regarding this second argument, petitioner implies that Eleventh Circuit precedent compels a different result from our own caselaw. Third, petitioner argues that he is entitled to increase his basis in Level Propane because he incurred a cost when he lost "control" of Level Propane.
Respondent counters that neither petitioner's guaranty, the pledged stock, nor the bank's "control" over Level Propane constituted an economic outlay. Respondent also argues that Eleventh Circuit caselaw does not compel a different result.
We address the parties' contentions in turn. First, we state the general rules governing when a shareholder of an S corporation is entitled to deduct losses the S corporation sustained. Petitioner bears the burden of proof.4
When an S corporation incurs losses, the shareholders of the S corporation, unlike shareholders of a C corporation, can directly deduct their share of the entity level losses in accordance with the flowthrough rules of subchapter S. Section 1366(a)5 provides for the pro rata flowthrough of subchapter S corporation income, losses, and deductions to the shareholders. Section 1366(d)(1), however, limits the aggregate amount of flowthrough losses and deductions a shareholder may claim.
The losses cannot exceed the sum of the shareholder's adjusted basis in his or her stock and the shareholder's adjusted basis of any indebtedness of the S corporation to the shareholder. Sec. 1366(d)(1)(A) and (B). This restriction applies because the disallowed amount exceeds the shareholder's economic investment in the S corporation and, because of the limited liability accorded to S corporation shareholders, the amount does not have to be repaid. The disallowed losses and deductions may be carried forward indefinitely, however, and claimed when and to the extent that the shareholder increases his or her basis in the S corporation.6 See sec. 1366(d)(2).
A taxpayer must make an economic outlay for a loan to create basis. A taxpayer makes an economic outlay when he or she incurs a "cost"7 on a third-party loan or is left poorer in a material sense after the transaction. Putnam v. Commissioner [57-1 USTC ¶ 9200], 352 U.S. 82 (1956); Estate of Bean v. Commissioner [2001-2 USTC ¶ 50,669], 268 F.3d 553, 558 (8th Cir. 2001), affg. [Dec. 54,125(M)] T.C. Memo. 2000-355; Bergman v. United States [99-1 USTC ¶ 50,475], 174 F.3d 928, 930 n. 6 (8th Cir. 1999); Estate of Leavitt v. Commissioner [89-1 USTC ¶ 9332], 875 F.2d 420, 422 (4th Cir. 1989), affg. [Dec. 44,557] 90 T.C. 206 (1988); Brown v. Commissioner [83-1 USTC ¶ 9364], 706 F.2d 755, 756 (6th Cir. 1983), affg. [Dec. 38,361(M)] T.C. Memo. 1981-608; Spencer v. Commissioner [Dec. 52,554], 110 T.C. 62, 83-84 (1998), affd. without published opinion [99-2 USTC ¶ 50,830] 194 F.3d 1324 (11th Cir. 1999); Underwood v. Commissioner [Dec. 33,016], 63 T.C. 468, 477 (1975), affd. [76-2 USTC ¶ 9557] 535 F.2d 309 (5th Cir. 1976); Prashker v. Commissioner [Dec. 31,583], 59 T.C. 172 (1972); Perry v. Commissioner [Dec. 30,176], 54 T.C. 1293, 1296 (1970), affd. [71-2 USTC ¶ 9502] 392 F.2d 458 (8th Cir. 1971); Raynor v. Commissioner [Dec. 29,103], 50 T.C. 762, 770-771 (1968); Horne v. Commissioner [Dec. 14,610], 5 T.C. 250, 254 (1945).
Against this background, we now address whether petitioner may increase his basis in the S corporation by the amount of the loan. We address specifically petitioner's contention that his personal loan guaranty, the pledge of stock, and the bank's "control" of Level Propane, either singly or collectively, constitute an economic outlay.
Shareholder guaranties of loans to an S corporation do not constitute an economic outlay. Estate of Leavitt v. Commissioner, supra; Brown v. Commissioner, supra; Spencer v. Commissioner, supra; Calcutt v. Commissioner, [Dec. 42,026], 84 T.C. 716, 719-720 (1985); Perry v. Commissioner, supra; Raynor v. Commissioner, supra; Hafiz v. Commissioner [Dec. 52,620(M)], T.C. Memo. 1998-104. But see Selfe v. United States [86-1 USTC ¶ 9115], 778 F.2d 769, 773 n. 7 (11th Cir. 1985). Guaranteeing a bank loan does not constitute an economic outlay because the shareholder is only secondarily liable. See Putnam v. Commissioner, supra at 85. A shareholder must perform under the guaranty to increase basis in the S corporation.8 Perry v. Commissioner [68-1 USTC ¶ 9297], 392 F.2d 458 (8th Cir. 1968) (). But see Selfe v. United States, supra (...
To continue reading
Request your trial