Uri v. C.I.R., s. 89-9014

• Decision Date: 18 November 1991
• Docket Number: 89-9015,Nos. 89-9014,s. 89-9014
• Citation: 949 F.2d 371
• Parties: -5891, 91-2 USTC P 50,556 Lawrence R. URI, Jr. and Cathaleen T. Uri, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. Stevens J. TOWNSDIN and Renate Townsdin, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Tenth Circuit

Page 371

949 F.2d 371

68 A.F.T.R.2d 91-5891, 91-2 USTC P 50,556

Lawrence R. URI, Jr. and Cathaleen T. Uri, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

Stevens J. TOWNSDIN and Renate Townsdin, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

Nos. 89-9014, 89-9015.

United States Court of Appeals Tenth Circuit.

Nov. 18, 1991.

Lawrence R. Uri, Jr., of Paulsen, Buechel, Swenson, Uri & Brewer, Chartered, Concordia, Kan., for petitioners-appellants.

Teresa E. McLaughlin, Tax Div., Dept. of Justice, Washington, D.C. (Shirley D. Peterson, Gary R. Allen, and Richard Farber, Dept. of Justice, with her on the briefs), for respondent-appellee.

Before HOLLOWAY and BALDOCK, Circuit Judges, and GREENE ^*, District Judge.

HOLLOWAY, Circuit Judge.

The issue in these consolidated appeals is whether a shareholder in a subchapter S corporation who personally guarantees a bank loan to the corporation may increase his or her adjusted basis in the corporation's stock by the prorated amount of the guarantee in order to increase the available loss deduction under the applicable version of I.R.C. § 1374. In the cases before us, the Tax Court approved the Commissioner's disallowance of petitioners' enhanced loss deductions. Guided by a recent Tenth Circuit opinion concerning this controlling issue, we affirm.

The issue presented is one of law. "We review the Tax Court's decision 'in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury.' 26 U.S.C. § 7482. Consequently, we review the Tax Court's determinations of law de novo. See In re Ruti-Sweetwater, Inc., 836 F.2d 1263, 1266 (10th Cir.1988)." Estate of Leder v. Comm'r, 893 F.2d 237, 240 (10th Cir.1989). The facts are thoroughly set forth in the Tax Court's Memorandum Findings of Fact and Opinion. Uri v. Comm'r, 56 T.C.M. (CCH) 1217 (1989). We briefly summarize them here to place the issue in context.

During the tax years in question, petitioners Cathaleen Uri and Stevens J. Townsdin ¹ were stockholders in The Old Opera House Mall Company (referred to as "the corporation" in this opinion), formed by Mrs. Uri and Mr. Townsdin as the business vehicle for renovation of a building in downtown Concordia, Kansas. After renovation, the corporation planned to operate a small retail mall and a dinner theater in the building. Mrs. Uri and Mr. Townsdin, also partners in an accounting firm, each contributed $10,000 cash to capitalize the corporation and received 50% of the corporation's stock. The corporation elected to be taxed as a small business corporation under subchapter S of the Internal Revenue Code. The corporation borrowed money from a local bank to repay interim loans for construction and equipment. This loan was secured by the real estate and assets of the corporation and by the personal guarantees of Mrs. Uri and Mr. Townsdin. Ninety percent of the loan was also guaranteed by the Small Business Administration (SBA).

Unfortunately, after the building was renovated, business was not sufficiently profitable to cover the loan payments, and the corporation suffered severe financial losses. After the SBA sent petitioners a demand for satisfaction under their guarantees on the accelerated note, petitioners filed individually for bankruptcy under Chapter 7 and their personal guarantees of the loan were discharged in the bankruptcy proceedings. Eventually, after strenuous efforts to financially revive the corporation failed, the corporation filed for bankruptcy. Under Chapter 7 liquidation, its real property and other assets were sold at a marshal's sale.

I.R.C. § 1374 ² allowed a pro-rata pass-through of net corporate losses to subchapter S corporate shareholders up to the amount of the taxpayer's adjusted basis in corporate stock plus the adjusted basis of the corporation's debt to the same taxpayer. In this case, Mrs. Uri's basis in the corporation's stock and Mr. Townsdin's basis in the corporate stock that resulted from their initial respective investments of $10,000 were extinguished by the losses they claimed on their 1981 returns. However, on Mr. and Mrs. Uri's joint returns for 1982 and 1983 and on Mr. and Mrs. Townsdin's joint return for 1983, petitioners claimed that their adjusted basis included a pro-rata share of the amount of the corporate loan each had personally guaranteed, resulting in their claims of a net business loss deduction for the tax years in question.

The Commissioner disallowed these pass-through losses. In denying the amount personally guaranteed as part of petitioners' § 1374 allowance for subchapter S loss pass-through, the Commissioner noted that petitioners were never called upon to make an actual economic transfer for the benefit of the corporation under the guarantee.

In their petitions to the Tax Court, petitioners noted that they had suffered considerable economic impact because the guarantees had forced each of them into personal bankruptcy at significant personal financial loss. They noted that the interrelationship of their personal finances, the finances of their joint accounting firm, and the prospective finances of the corporation were all taken into account when the bank extended the loan to the corporation. Petitioners argued that because the loan was made primarily on the strength of their personal financial worth and the income from their accounting business, it was in substance a loan to them and a subsequent contribution by them of the funds to the corporation's capital. In the alternative, they characterized the loan as corporate debt to them because the bank would not have made the loan without their personal guarantees. Under either argument, they claimed that the amount of the guarantee should be part of their pass-through loss limitation under § 1374.

The Tax Court denied the taxpayers' petitions, citing its opinion in Estate of Leavitt v. Comm'r, 90 T.C. 206 (1988), aff'd, 875 F.2d 420 (4th Cir.), cert. denied, 493 U.S. 958, 110 S.Ct. 376, 107 L.Ed.2d 361 (1989). Under the Tax Court ruling, petitioners' basis in the corporation's stock was limited to contributions of cash or other property, in accord with the definition of "basis" from I.R.C. § 1012 and the definition of "cost" from Treas.Reg. § 1.1012-1(a). Uri, 56 T.C.M. (CCH) at 1220. The Tax Court held that because petitioners' personal guarantees were neither cash nor other property, the guarantees could not be considered as part of petitioners' adjusted basis in the corporation's stock. Id. In addition, in rejecting application of debt-equity principles to this transaction, the court cited its ruling in Estate of Leavitt, requiring actual economic outlay by petitioners rather than characterizing a mere demand for payment under the guarantee as corporate debt to petitioners. Id. at 1221. ³ Petitioners appealed to this court.

Petitioners correctly note a split among the circuits which have considered this issue. Compare Selfe v. United States, 778 F.2d 769 (11th Cir.1985) (approving theory of pro-rata inclusion of personal loan guarantees in shareholders' adjusted basis in subchapter S corporate stock for the purpose of the pass-through loss deduction, emphasizing analysis of whether the lender looked primarily to the shareholder or to the corporate entity for repayment, reversing summary judgment for government and remanding for factual determination whether bank loan to corporation was in reality loan to taxpayer) with Estate of Leavitt (disapproving such inclusion and affirming the Tax Court's decision on the issue, emphasizing that subchapter S shareholders must abide by the form of the transaction of which they are a part, rather than using hindsight to construct an explanation of the transaction which gives them the best tax result) and Brown v. Comm'r, 706 F.2d 755, 756 (6th Cir.1983) (subchapter S shareholder/guarantor must make economic outlay to convert loan guarantee into investment). After this appeal was filed two more circuits, including this one, have considered the issue and joined the Fourth...