Meruelo v. Commissioner of Internal Revenue, 050619 FED11, 18-11909

Docket Nº:18-11909
Opinion Judge:WILLIAM PRYOR, CIRCUIT JUDGE
Party Name:HOMERO F. MERUELO, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
Judge Panel:Before WILLIAM PRYOR and NEWSOM, Circuit Judges, and VRATIL, District Judge.
Case Date:May 06, 2019
Court:United States Courts of Appeals, Court of Appeals for the Eleventh Circuit
 
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HOMERO F. MERUELO, Petitioner-Appellant,

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 18-11909

United States Court of Appeals, Eleventh Circuit

May 6, 2019

Petition for Review of a Decision of the United States Tax Court Agency No. 001795-13

Before WILLIAM PRYOR and NEWSOM, Circuit Judges, and VRATIL, [*] District Judge.

WILLIAM PRYOR, CIRCUIT JUDGE

This appeal from the disallowance of a taxpayer's claimed deduction for his share of losses suffered by an S corporation presents the following issue: whether monetary transfers between various business entities partly owned by the taxpayer and an S corporation that were later reclassified as loans from the taxpayer to the S corporation established a "bona fide indebtedness" that "runs directly" to the taxpayer. Treas. Reg. § 1.1366-2(a)(2)(i); see also 26 U.S.C. § 1366. Homero Meruelo was a shareholder of Merco of the Palm Beaches, Inc., which suffered a nearly $27 million loss after banks foreclosed on its condominium complex. Meruelo asserted that he had a sufficient basis in Merco's indebtedness for him to deduct $13 million as his share of the loss. Meruelo claimed basis from a $5 million capital contribution he made to Merco and more than $9 million of indebtedness from net transfers through various other business entities in which he held an interest. The Internal Revenue Service determined that he could claim only the $5 million basis and not the $9 million because any debt ran from Merco to the other entities. The Tax Court later ruled that Meruelo had failed to establish a bona fide indebtedness of $9 million running directly to him and that he failed to establish that he made an "actual economic outlay" toward the debt. Because the Tax Court correctly determined that Meruelo did not establish a bona fide indebtedness that ran directly to him, we affirm.

I. BACKGROUND

Meruelo, a real estate developer in south Florida, owns interests in several S corporations, partnerships, and limited liability companies. One of these entities was Merco of the Palm Beaches, Inc., an S corporation Meruelo incorporated in March 2004. Meruelo held 49 percent of Merco's stock.

Subchapter S of the Internal Revenue Code provides "a pass-through system under which corporate income, losses, deductions, and credits are attributed to individual shareholders in a manner akin to the tax treatment of partnerships." Buffered v. Comm'r, 506 U.S. 523, 525 (1993). A shareholder's ability to deduct his proportionate share of a corporation's net operating losses is limited by the sum of his basis in his stock and the corporate indebtedness to him. See 26 U.S.C. § 1366(d)(1). In other words, the shareholder can increase his basis by contributing capital to the corporation or by lending money to it.

Meruelo incorporated Merco to purchase a condominium complex in a bankruptcy sale. In early 2004, the bankruptcy court approved the sale and required Merco to pay a $10 million non-refundable deposit to secure the property. To raise funds for his share of the deposit, Meruelo obtained a personal loan.

Meruelo transferred $4, 985, 035 of the loan proceeds to Merco Group at Akoya, an S corporation in which he and his mother each held a 50 percent interest. In March 2004, Akoya transferred into Merco's escrow account $5 million-$4, 985, 035 of Meruelo's loan proceeds and $14, 965 of Akoya's own funds-to cover half the required deposit. Akoya had also previously transferred to Merco enough funds to cover the $5 million balance of the deposit. The Commissioner does not dispute that the $4, 985, 035 transfer gave Meruelo a shareholder basis in that amount in Merco.

From 2004 to 2008, Merco entered into hundreds of transactions with various partnerships, S corporations, and limited liability companies in which Meruelo held an interest. These Merco affiliates often paid expenses, such as payroll costs, for each other or for Merco to simplify accounting and enhance liquidity. The payor company recorded these payments to its affiliates as accounts receivable, and the payee company recorded them as accounts payable. Between 2004 and 2008, Merco affiliates made more than $15 million in payments to or on behalf of Merco, and Merco repaid its affiliates less than $6 million of these payments. On December 31 of each year, Merco's books and records showed substantial net accounts payable to its affiliates.

Luis Carreras, a certified public accountant, prepared the tax returns filed by Meruelo, Merco, and the Merco affiliates. When preparing Merco's tax return for a given year, Carreras would net Merco's accounts payable to its affiliates, as shown on Merco's books as of the preceding December 31, against Merco's accounts receivable from its affiliates. If Merco had net accounts payable, Carreras reported that amount as a "shareholder loan" on Merco's tax return. Carreras then allocated a percentage of this indebtedness to Meruelo based on Meruelo's ownership interests in the various affiliates that had transferred funds to Merco.

In March 2004, Carreras drafted a promissory note for Meruelo purportedly to make a $10 million unsecured line of credit available to Merco at a six percent interest rate. Carreras testified that, when he prepared Meruelo's and Merco's tax returns for tax years 2004 to 2008, he made an annual charge to Merco's line of credit for an amount equal to Meruelo's calculated share of Merco's net accounts payable to its affiliates for the preceding year.

In 2008, Merco incurred a loss of $26, 605, 840 when banks foreclosed on the condominium complex it purchased in 2004. Merco reported this loss on its income tax return, and Merco allocated 49 percent of the loss to Meruelo.

Meruelo filed income tax returns for 2005 and 2008. On his 2005 return, he reported taxable income of $13, 895, 731 and tax due of $4, 843, 976. On his 2008...

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