Perry v. Comm'r of Internal Revenue
| Decision Date | 18 November 1966 |
| Docket Number | Docket No. 1018-64. |
| Parties | WILLIAM H. PERRY AND MARION E. PERRY, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
William C. Myers, Jr., for the petitioners.
Hugh C. McMahon, for the respondent.
The allowable portion of a net operating loss properly deductible by a shareholder in an electing small business corporation does not include corporate debts to third parties which have been guaranteed by such shareholder. The obligation of the shareholder-guarantor was secondary and would not support the proposition of ‘(an) indebtedness of the corporation to the shareholder’ under sec. 1374(c)(2)(B), I.R.C. 1954.
The respondent determined deficiencies in the petitioners' Federal income taxes for the calendar years 1960 and 1961 in the respective amounts of $3,324.18 and $2,118.96. Some concessions have been made, and the only issue for our decision is whether the petitioner's deductible share of the net operating losses incurred by an electing small business corporation exceeds the amounts allowed by the respondent.
Some of the facts have been stipulated and are incorporated herein by this reference.
William H. Perry and Marion E. Perry, husband and wife, filed joint Federal income tax returns for the calendar years 1960 and 1961 with the district director of internal revenue, Kansas City, Mo. William H. Perry is hereafter referred to as the petitioner.
Cardinal Castings, Inc. (hereafter referred to as Cardinal Castings), was incorporated under the laws of the State of Missouri on March 11, 1960. During the years in issue, the petitioner owned 2,998 shares of capital stock in Cardinal Castings, his wife owned 1 share, and his son, David, owned 1 share. They owned all the issued and outstanding stock of the company. The petitioners paid $2,999 for their 2,999 shares of stock.
Cardinal Castings began business in March of 1960 and made a timely election to be taxed as a small business corporation within the purview of subchapter S, sections 1371, et seq., of the 1954 Code.1 The election was filed on March 21, 1960.
Cardinal Castings, an accrual basis taxpayer, elected to file its Federal income tax returns on a fiscal year basis with the first taxable period ending October 31, 1960. For the period from March 30, 1960, through October 31, 1960, the company sustained a net operating loss of $9,294.30. For the next fiscal year, running from November 1, 1960, through October 31, 1961, that company incurred a net operating loss of $6,069.53.
At the end of its first fiscal year, on October 31, 1960, Cardinal Castings had various accounts payable outstanding and an overdraft in its checking account. These liabilities totaled $5,158.30. The petitioner contacted some of these creditors and guaranteed the payment by Cardinal Castings of at least some of these debts. Despite this guaranty, Cardinal Castings paid, with checks drawn on its own checking account, about $4,000 on these accounts during its next fiscal year.
At the end of its second fiscal year (Oct. 31, 1961), Cardinal Castings again had various accounts payable outstanding. These accounts totaled $3,943.82. Again, the petitioner contacted some of these creditors and guaranteed payment by Cardinal Castings either in part or in full. During the next fiscal year that company paid off these accounts completely, again, with checks drawn on its own account.
On October 31, 1961, Cardinal Castings owed the petitioners rent on a building which it used in the amount of $1,900. Of this amount $1,200 was applicable to the fiscal year running from November 1, 1960, to October 31, 1961. The petitioners reported this $1,200 on their Federal income tax return for 1961. The remaining $700 of the accrued rent represents the amount of the unpaid rent for the fiscal year ending October 31, 1960.2
At an undetermined time before October 31, 1961, the petitioners advanced $1,421.50 in cash to Cardinal Castings in exchange for the company's promissory note in the same amount date August 26, 1961. This note was payable on demand to the petitioner and provided for interest at 6 percent payable annually.
Sometime after October 31, 1961, the petitioner executed and delivered to Cardinal Castings an instrument purporting to be a demand promissory note which had been predated to October 31, 1961. The instrument was drawn in the amount of $7,942.33 and was payable to the company's order. This transaction is reflected on the company's books by an entry dated October 31, 1962, in the notes receivable account. The balance sheet attached to the company's Federal income tax return for the fiscal year ending October 31, 1961, indicates that the company had no notes receivable on October 31, 1961.
Sometime after October 31, 1961, Cardinal Castings executed and delivered to the petitioner an instrument purporting to be a promissory note due on January 1, 1964, which also had been predated to October 31, 1961. This instrument was also drawn in the amount of $7,942.33 and was payable to the order of the petitioner. This transaction is also first reflected on the company's books by an entry dated October 31, 1962, in the notes payable account. The balance sheet attached to the company's Federal income tax return for the year ending October 31, 1961, indicates that the company had notes payable outstanding only in the amounts of $1,421.50 at the end of said year.
The petitioners did not advance cash or other valuable consideration to Cardinal Castings prior to, or on October 31, 1961, in connection with the exchange of notes above described, nor were such notes in fact executed and delivered on or before October 31, 1961.
On October 31, 1960, the petitioners' adjusted basis in the capital stock of Cardinal Castings was their cost of $2,999, and their adjusted basis of the company's indebtedness to them was $700.
On October 31, 1961, the petitioners' adjusted basis in the company's capital stock was zero, and the adjusted basis of the company's indebtedness to them was $2,621.50.
OPINIONWe are called upon to decide the allowable portion of a net operating loss properly deductible by a shareholder in an electing small business corporation. Specifically, the issue at hand is whether ‘the adjusted basis * * * of any indebtedness of the corporation to the shareholder’ includes the amount of the company's accounts payable which have been personally guaranteed by the shareholder. Sec. 1374(c)(2)(B).
Section 1374 of the Code gives each shareholder of an electing small business corporation the right to deduct on his individual or joint Federal return an amount equal to his prorata share of the corporation's net operating loss. This deduction is subject to the important limitations that it may not exceed the shareholder's adjusted basis in the corporation's stock and the adjusted basis of any corporate indebtedness to him determined as of the close of the company's taxable year.
During the years in issue the petitioners owned 2,999 shares of stock in Cardinal Castings which cost them $2,999. During the period from March 11, 1960, through October 31, 1960, the petitioners did not advance money to Cardinal Castings, nor did they pay any of the company's various debts. The respondent has stipulated, however, that the company became indebted to the petitioners during this period for rent in the amount of $700.
For its first fiscal year Cardinal Castings had a net operating loss of $9,294.30. On their joint Federal return for the calendar year 1960 the petitioners claimed a deduction of $8,440.083 as their prorata share of this net operating loss. The respondent now contends that the petitioners are entitled to a deduction of only $3,699 (their basis in the stock of $2,999 plus the unpaid rent of $700).
During the corporation's fiscal year ended ...
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