Millar v. Comm'r of Internal Revenue
| Citation | 67 T.C. 656 |
| Decision Date | 10 January 1977 |
| Docket Number | Docket Nos. 5884-72,5893-72.,5892-72,5888-72,5885-72,5889-72 |
| Parties | GAVIN S. MILLAR, ET AL.,1 PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | United States Tax Court |
OPINION TEXT STARTS HERE
Amounts were paid into the capital of a subch. S corporation on behalf of petitioners, evidenced by nonrecourse notes and secured by their stock in the corporation. Petitioners deducted losses incurred by the corporation as stockholders, not to exceed their basis in the stock, including such advances. Ultimately, petitioners surrendered their stock in discharge of the notes. Held, the advances constituted loans, and not gifts, to the petitioners. Further held, on surrender of the stock in payment of the notes, petitioners realized a gain to the extent that the face amount due on the notes exceeded the adjusted basis of the stock, regardless of the fair market value of such stock. Edmund W. Ridall, Jr., and R. K. Conrad, for the petitioners.
Joseph M. Abele, for the respondent.
SUPPLEMENTAL OPINION
In our opinion filed April 22, 1975 (T.C. Memo. 1975-113), the Court held that the basis of petitioners in the stock of Grant County Coal Corp., a subchapter S corporation, for purposes of determining the deductibility by its shareholders of losses sustained by the corporation, should include the sum of $500,000 contributed to the corporation on behalf of its shareholders by R. H. Jamison, Jr., in the form of loans evidenced by nonrecourse notes in the amount of the respective contributions by each shareholder, payment of which was secured solely by a pledge of their respective shares. In so holding, this Court stated that with respect to this issue the result would be the same whether advances are treated as a ‘debt’ of as ‘gifts.’
On appeal, the U.S. Court of Appeals for the Third Circuit remanded the case in order that the Tax Court might determine whether the amounts contributed to the capital of the corporation by or on behalf of the petitioners constituted loans from R. H. Jamison, Jr., or whether such amounts should be treated as gifts by him to the petitioners. Millar v. Commissioner, 540 F.2d 184 (3d Cir. 1976). In the event that this Court should determine, on remand, that the amounts contributed to the capital of the corporation constituted ‘loans' to the petitioners, the Court of Appeals requested that this Court consider the question whether the discharge of nonrecourse obligations should be included in the amount realized from the sale or other disposition of the stock by petitioners where the fair market value of such stock is less than the amount of the debt which was extinguished.
In the trial of the case before the Tax Court, petitioners did not contend that the amounts purportedly ‘loaned’ to them by Mr. Jamison should be treated as gifts. On the contrary, petitioners were given an opportunity to present the testimony of R. H. Jamison, Jr., for the purpose of raising the issue and declined to do so. In petitioners' brief, the Tax Court was requested to find the following:
(1) Grant was a West Virginia business corporation, electing Internal Revenue Code subchapter S treatment, and petitioners were Grant shareholders consenting to such election (Stip. pars. 11 and 12).
(2) Since August 1, 1964, petitioners were, and even now continue to be, shareholders of Grant (Stip. pars. 30 and 33).
(3) From July 28, 1964, to December 20, 1965, petitioners borrowed $500,000 from Jamison and forwith paid the total thereof into Grant as capital to be used for corporate purposes (Stip. pars. 26 and 27).
(4) As security for Jamison's loans to petitioners, demand, promissory, nonrecourse notes were signed by petitioners and their Grant stock was assigned by petitioners to Jamison by separate stock powers, as collateral to their notes (Stip. pars. 26, 27, 31).
Again, in the same brief under the title ‘Did R. H. Jamison, Jr. Make Gifts To Petitioners?’, petitioners make the following statement:
Although it is Jamison's immediate problem, petitioners know of no action or event, delivery, notice, or otherwise, usually required in the making of a completed gift, that Jamison has taken or participated in involving Grant stock or the petitioners' notes payable to him, that would constitute a gift, reportable to respondent.
On the basis of the record, the Court is unable to find that there was a gift of $500,000 to the petitioners by R. H. Jamison, Jr. He caused the Grant County Coal Corp. to be organized and transferred certain leases to the corporation, with the expectation that the venture would be successful. He caused the stock to be issued in the names of the petitioners and his business associates without consideration, at which time it must be assumed that the stock had no value. In order to provide working capital for the corporation, Mr. Jamison from time to time issued checks totaling $500,000 in the names of the respective shareholders in order that this amount might be contributed by them to the corporation. Mr. Jamison then took back nonrecourse notes from each of the shareholders secured by their stock.
If the venture had met with success, it must be presumed that Mr. Jamison intended to recoup the amount of his advances from the petitioners. In fact, Mr. Jamison in turn borrowed the sum of $500,000 from the Mellon National Bank & Trust Co., further evidencing an intent on his part that the petitioners would ultimately be able to repay the $500,000 which he had advanced to them; and Mr. Jamison would in turn repay his loan to the bank.
Mr. Jamison's intent to recover his loan of $500,000 from the petitioners is further evidenced by the fact that he did not report the amounts loaned to them as gifts for purposes of the internal revenue laws.
In the absence of any proof to the contrary, the transaction speaks for itself. It was Mr. Jamison's intent to make a nonrecourse loan to the petitioners and not a ‘gift.’ As an experienced coal operator, Mr. Jamison obviously felt that he would be able to make some money for them from the operations of the Grant County Coal Corp. and get his money back.
This Court found that the petitioners, and not Mr. Jamison, were the real shareholders of Grant County Coal Corp. As such, petitioners made a valid election to be taxed under subchapter S of the Code (sec. 1372). Pursuant to such election, petitioners were chargeable with their pro rata share of the net taxable income and operating losses of the corporation (secs. 1373-1374). With respect to the losses allowed, however, section 1374(c)(2) provides, as follows:
(2) LIMITATION.—A shareholder's portion of the net operating loss of an electing small business corporation for any taxable year shall not exceed the sum of—
(A) the adjusted basis (determined without regard to any adjuctment under section 1376 for the taxable year) of the shareholder's stock in the electing small business corporation, determined as of the close of the taxable year of the corporation (or, in respect of stock sold or otherwise disposed of during such taxable year, as of the day before the day of such sale or other disposition), and
(B) the adjusted basis (determined without regard to any adjustment under section 1376 for the taxable year) of any indebtedness of the corporation to the shareholder, determined as of the close of the taxable year of the corporation (or, if the shareholder is not a shareholder as of the close of such taxable year, as of the close of the last day in such taxable year on which the shareholder was a shareholder in the corporation).
The losses deductible by petitioners were thus limited to the adjusted basis of their stock of the corporation. At the outset, such basis was a nominal amount of ‘zero.’
In order to provide working capital for the corporation, Mr. Jamison gave the petitioners checks from time to time, as needed, totaling $500,000, which were endorsed over by them as contributions to the capital of the corporation. Petitioners executed a series of nonrecourse notes with the stock as collateral to evidence this indebtedness. Except for the contributions to capital obtained in this manner, petitioners would not have been entitled to deduct the losses of the corporation in the first instance. The respondent's disallowance of such deductions would have been sustained by the Court.
In reliance on the rule enunciated by Crane v. Commissioner, 331 U.S. 1 (1947), this Court held that petitioners were entitled to include as a part of their adjusted basis within the meaning of section 1374(c)(2) the respective contributions to the capital of the corporation made out of ‘borrowed’ funds. To the extent of such contributions, the petitioners received the benefit of deducting the losses sustained by the corporation.
At the time that these ‘loans' were contributed to the corporation, it cannot be said that the value of petitioners' stock which was...
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