Shaver v. Commissioner
| Decision Date | 23 December 1993 |
| Docket Number | Docket No. 3656-92. |
| Citation | 66 T.C.M. 1766 |
| Parties | Arnold W. Shaver, Jr. and Louann Shaver v. Commissioner. |
| Court | U.S. Tax Court |
Arnold W. Shaver, Jr. and Louann Shaver, pro sese. Russell A. Acree III, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined deficiencies in petitioners' joint Federal income taxes and additions to tax as follows:
Additions to Tax
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Year Deficiency Sec. 6651(a)(1) Sec. 6653(a)(1) Sec. 6653(a)(2) Sec. 6653(a)(1)(A) Sec. 6653(a)(1)(B) Sec. 6661
1985 $11,058 $ -- $553 * $ -- -- $ --
1987 19,558 1,760 -- -- 978 * 4,676
1988 93,356 -- -- -- 4,668 -- 23,339
* 50 percent of the interest due on the portion of the underpayment attributable to negligence
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
After settlement, the primary issues remaining for decision are: (1) The amount of Arnold W. Shaver, Jr.'s (petitioner) tax basis in the stock and indebtedness of Fotostop, Inc. (Fotostop), a small business corporation (S corporation); (2) whether petitioner is entitled to bad debt deductions with respect to loans made to Fotostop; and (3) whether petitioners are entitled to a deduction with respect to a loss incurred on the sale of their personal residence.
Some of the facts have been stipulated and are so found. Petitioners resided in San Antonio, Texas, at the time the petition was filed.
On July 6, 1982, Fotostop was incorporated in the State of Oklahoma. Fotostop was the corporate general partner of a limited partnership named Fotostop Tulsa, Ltd. (the partnership), which partnership was engaged in owning and operating 1-hour photographic film developing and printing laboratories in Tulsa, Oklahoma.
From the time of Fotostop's incorporation in 1982, until the end of its 1988 taxable year, Fotostop's shareholders elected to have Fotostop treated as an S corporation. Fotostop's taxable years began on February 1 and ended on January 31 of each year, with the exception of its last 2 taxable years which were short taxable years which began respectively on February 1, 1987, and ended on December 31, 1987, and on January 1, 1988, and ended on August 31, 1988.
Between July 6, 1982, and January 31, 1984, petitioner owned 18.996 percent of the outstanding stock of Fotostop. Sometime late in 1984 or early 1985, petitioner's stock interest in Fotostop increased to 33.33 percent. The total cash investment of all of the shareholders in Fotostop was $4,255. Petitioner, however, apparently invested no cash in Fotostop, and petitioner's tax basis in his stock in Fotostop therefore was zero.
In October of 1983, petitioner made a personal guarantee of a $96,000 loan obtained by Fotostop from the United Bank of Texas.
During the taxable years indicated, petitioner made cash loans to Fotostop, as follows:
Fotostop's Taxable Year Cash Loaned by Petitioner
Ending to Fotostop
Jan. 31, 1985 ............... $30,000
Jan. 31, 1986 ............... 40,726
Dec. 31, 1987 ............... 24,000
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Petitioner's Total Cash Loans ... $94,726
The loan of $24,000 made by petitioner to Fotostop during Fotostop's taxable year ending December 31, 1987, was made by petitioner by way of a payment to the United Bank of Texas in partial performance of the guarantee petitioner had made with respect to Fotostop's 1983 loan from the United Bank of Texas.
On August 2, 1984, Fotostop repaid to petitioner $10,000 on the loan it had received from petitioner during its taxable year ending January 31, 1985. On February 28, 1986, Fotostop repaid to petitioner an additional $25,589 on the loans it had received from petitioner. The $59,137 balance on petitioner's loans to Fotostop remains outstanding.
On July 1, 1988, the partnership was dissolved under an agreement between Fotostop and the partnership's limited partners. Also, on or about August 31, 1988, Fotostop was dissolved.
On November 4, 1985, petitioners purchased a house and property located at 3843 Morgans Creek, San Antonio, Texas. Beginning in late 1987, while petitioners continued residing in the house, petitioners attempted to sell or rent the house. Petitioners sold the house and property in May of 1988, incurring a $38,950 loss on the sale.
On January 5, 1989, petitioner filed in the U.S. Bankruptcy Court for the Western District of Texas (bankruptcy court) a voluntary petition for relief under chapter 7 of the Bankruptcy Code.
On April 25, 1989, the bankruptcy court granted petitioner a discharge under chapter 7 of the Bankruptcy Code. Under the discharge, petitioner was discharged from any further liability on his guarantee of the 1983 loan Fotostop had obtained from the United Bank of Texas.
Fotostop incurred net operating losses in each of its taxable years which losses (due to Fotostop's status as an S corporation and subject to the shareholders' tax bases in their stock and indebtedness of Fotostop) passed through to Fotostop's shareholders.
Petitioner's pro rata share of Fotostop's net operating losses for the years indicated is as follows:
Petitioner's Pro Rata Share
Fotostop's Taxable Year of Fotostop's Net Operating
Ending Losses
Jan. 31, 1983 ............... $ 2,913
Jan. 31, 1984 ............... 12,314
Jan. 31, 1985 ............... 24,638
Jan. 31, 1986 ............... 26,338
Jan. 31, 1987 ............... 53,284
Dec. 31, 1987 ............... 47,565
Aug. 31, 1988 ............... 12,606
On petitioner's Federal income tax returns for 1983 through 1986, petitioner claimed and was allowed as pass-through ordinary loss deductions the full amount of his pro rata share of Fotostop's net operating losses for each of Fotostop's taxable years ending in 1983 through 1986.
On November 21, 1988, petitioners' 1987 joint Federal income tax return was filed. On that return, petitioner claimed an ordinary loss deduction of $53,284 with respect to the pass-through of petitioner's share of Fotostop's net operating loss with respect to Fotostop's taxable year ending January 31, 1987, and petitioner also claimed an ordinary bad debt deduction of $39,000 with respect to the loans petitioner had made to Fotostop.
On April 17, 1989, petitioners' 1988 joint Federal income tax return was timely filed. On that return, petitioner claimed an ordinary bad debt deduction of $24,000 with respect to the $24,000 payment petitioner made in 1987 on his guarantee of Fotostop's 1983 loan from the United Bank of Texas, and petitioners claimed an ordinary loss deduction of $38,950 with respect to a loss on the sale of their house.
Also in April of 1989, petitioners timely filed an amended 1985 joint Federal income tax return, in which petitioners claimed a $32,765 net operating loss carryback from 1988 (primarily due to the $38,950 ordinary loss deduction claimed with respect to the loss on the sale of their house) and a refund arising therefrom of $11,058, which claim respondent apparently allowed.
On subsequent audit of petitioners' 1987 and 1988 joint Federal income tax returns, respondent determined that petitioner did not have a tax basis in the stock and indebtedness of Fotostop that would support petitioner's claimed $53,284 pass-through loss arising from Fotostop's net operating loss for 1987, that petitioner was not entitled to the claimed bad debt deductions with respect to any of petitioner's loans to Fotostop, that petitioners were not entitled to a deduction relating to the loss on the sale of their house, and that petitioners were therefore not entitled to a net operating loss carryback from 1988 to 1985.
OpinionUnder section 1366, S corporation losses and deductions are passed through to the shareholders. The total amount, however, of pass-through losses and deductions that can be properly claimed by a shareholder of an S corporation is limited under section 1366(d) to the sum of the shareholder's adjusted basis in the stock of the corporation and the shareholder's adjusted basis in indebtedness owed by the corporation to the shareholder.1
If in a particular tax year a shareholder does not have a sufficient tax basis in the stock and indebtedness of an S corporation to support the pass-through to the shareholder of the shareholder's entire pro rata share of the S corporation's losses, then the portion of the losses that is not passed through to the shareholder in that year is carried over to a subsequent year until the shareholder has a sufficient tax basis in the stock and indebtedness of the S corporation to support the losses. Sec. 1366(d)(2).
Generally, in order to qualify as "indebtedness" under section 1366(d), the indebtedness of the S corporation to the shareholder must have arisen as a result of an actual economic outlay by the shareholder. Harris v. United States [90-2 USTC ¶ 50,341], 902 F.2d 439, 443 (5th Cir. 1990); Estate of Leavitt v. Commissioner [Dec. 44,557], 90 T.C. 206, 217 (1988), affd. [89-1 USTC ¶ 9332] 875 F.2d 420 (4th Cir. 1989); Underwood v. Commissioner [Dec. 33,016], 63 T.C. 468, 476 (1975), affd. [76-2 USTC ¶ 9557] 535 F.2d 309 (5th Cir. 1976); Perry v. Commissioner [Dec. 30,176], ...
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