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Parties Involved:
Commissioner of Internal Revenue
Appellee
Renate Townsdin
Appellant
Stevens J. Townsdin
Appellant

Document Text:

PUBLISH 

FILED 

United St.ates Court of Appeals Tenth Circuit 

UNITED STATES COURT OF APPEALS 

TENTH CIRCUIT 

NOV 18 1991 

ROBERT L. HOECKER 

Clerk 

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. 

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) No. 89-9014 

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) No. 89-9015 

) (T.C. No. 16881-86) 

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CONSOLIDATED APPEALS FROM THE UNITED STATES TAX COURT 

Lawrence R. Uri, Jr., of Paulsen, Buechel, Swenson, Uri & Brewer, 

Chartered, Concordia, Kansas, for Petitioners-Appellants. 

Teresa E. McLaughlin, Tax Division, Department 

Washington, D.C. (Shirley D. Peterson, Gary R. Allen, 

Farber, Department of Justice, with her on the 

Respondent-Appellee. 

of Justice, 

and Richard 

briefs), for 

Appellate Case: 89-9015 Document: 010110097371 Date Filed: 11/18/1991 Page: 1 
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. 

* The Honorable J. Thomas Greene, United States District Judge 

of the District of Utah, sitting by designation. 

2 

Appellate Case: 89-9015 Document: 010110097371 Date Filed: 11/18/1991 Page: 2 
During the tax years in question, petitioners Cathaleen Uri 

and Stevens J. Townsdin1 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, 

1 

Mrs. Uri and Mr. Townsdin were individual stockholders in the 

corporation. Mr. Uri and Mrs. Townsdin were also petitioners in 

this tax appeal because they filed joint returns with their 

respective spouses. 

3 

Appellate Case: 89-9015 Document: 010110097371 Date Filed: 11/18/1991 Page: 3 
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. § 13742 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 

2 

Section 1374 was reenacted in 1982 as§ 1366(d)(l) in pt. II 

of the Subchapter S Revision Act of 1982, Pub. L. 97-354, 

96 Stat. 1669, 1678. All references to the Internal Revenue Code 

in this opinion refer to the version of that statute in effect 

during the tax years in question. 

4 

Appellate Case: 89-9015 Document: 010110097371 Date Filed: 11/18/1991 Page: 4 
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. 

was made primarily on 

Petitioners argued that because the loan 

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 (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 

§ 1012 and the definition of "cost" 

§ 1.1012-l(a). Uri, 56 T.C.M. (CCH) at 1220. 

"basis" from 

from Treas. 

The Tax Court 

I.R.C. 

Reg. 

held 

that because petitioners' personal guarantees were neither cash 

5 

Appellate Case: 89-9015 Document: 010110097371 Date Filed: 11/18/1991 Page: 5 
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. 

appealed to this court. 

Id. at 1221. 3 Petitioners 

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 

3 

Petitioners submitted two other arguments which the Tax Court 

rejected. Petitioners' suggested that the Tax Court look to 

I.R.C. provisions concerning partnership taxation for an analogous 

situation and rules. The Tax Court correctly noted that the 

partnership taxation statutes apply to partnerships, but not to 

the subchapter S corporation which Mrs. Uri and Mr. Townsdin 

elected to establish. Uri, 56 T.C.M. (CCH) at 1221. 

In addition, petitioners postulated that the "at-risk" loss 

limitations of I.R.C. § 465 would not disallow the increased passthrough loss deduction which they sought. However, the Tax Court 

correctly noted that § 465's provisions operate as a limitation 

placed on the loss deductions allowed by other provisions, 

including § 1374, rather than as independent or primary screening 

provisions. Id.; see I.R.C. § 465(a) (1) ( "any loss from [an 

activity to which this section applies] shall be allowed only to 

the extent •.. the taxpayer is at risk"). 

6 

Appellate Case: 89-9015 Document: 010110097371 Date Filed: 11/18/1991 Page: 6 
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 and Sixth Circuits in their analysis, leaving the Eleventh 

Circuit alone in the minority position. See Goatcher v. United 

States, 944 F.2d 747 (10th Cir. 1991); Harris v. United States, 

902 F.2d 439 (5th Cir. 1990). 

We are bound by our decision in Goatcher. There, this court 

refused to recharacterize a transaction as a different 

relationship between the parties than that reflected on the face 

of the financial documents used to structure the transaction. 

Under Goatcher, taxpayers must choose a form for transactions 

which accurately reflects the substance of the transactions. 4 The 

4 

It is permissible for the government to look behind the form 

of a transaction to its substance if the transaction is a sham 

intended for improper tax avoidance. 

A taxpayer is free to adopt such organization for his 

affairs as he may choose and having elected to do some 

business as a corporation, he must accept the tax 

disadvantages. 

On the other hand, the Government may not be 

required to acquiesce in the taxpayer's election of that 

(Footnote continued on next page) 

7 

Appellate Case: 89-9015 Document: 010110097371 Date Filed: 11/18/1991 Page: 7 
same requirement can be applied to petitioners' "debt-equity" 

argument here. They contend that the loan from the bank to the 

"thinly capitalized" corporation, personally guaranteed by the 

shareholders, was in substance a loan to the shareholders 

themselves, who then contributed the loan proceeds to the 

corporation as a capital infusion. However, Goatcher's analysis 

that the form of a taxpayer's transactions govern the tax 

ramifications of those transactions, Goatcher, 944 F.2d at 752, 

applies to this argument as well. Recharacterization of the 

transaction in pursuit of tax advantages was properly disallowed 

under the then-current statute. 

In addition to the arguments discussed above focusing on the 

personal guarantees by the taxpayers of the debts of the 

(Footnote continued): 

form for doing business which is most advantageous to 

him. The Government may look at actualities and upon 

determination that the form employed for doing business 

or carrying out the challenged tax event is unreal or a 

sham may sustain or disregard the effect of the fiction 

as best serves the purposes of the tax statute. To hold 

otherwise would permit the schemes of taxpayers to 

supersede legislation in the determination of the time 

and manner of taxation. 

Higgins v. Smith, 308 U.S. 473, 477-78 (1940). Compare Heyen v. 

United States, 945 F.2d 359, slip op. at 7 (10th Cir. 1991) (in 

context of analysis of improper gift tax avoidance, "substance 

over form analysis applies to gift tax, as well as to income tax, 

cases") with Goatcher, 944 F.2d at 752 (rejecting taxpayer's 

request that the court "disregard the form of the transaction and 

look to its substance"). See also Harris, 902 F.2d at 443: 

Ordinarily, taxpayers are bound by the form of the 

transaction they have chosen; taxpayers may not in 

hindsight recast the transaction as one that they might 

have made in order to obtain tax advantages. The IRS, 

however, often may disregard form and recharacterize a 

transaction by looking to its substance. 

(citations omitted). 

8 

Appellate Case: 89-9015 Document: 010110097371 Date Filed: 11/18/1991 Page: 8 
corporation, the taxpayers argued two additional issues, i.e., 

whether deductions for accrued interest by the corporation were 

proper because prospect of repayment was not so unlikely as to 

destroy the existence of a valid debt, and whether depreciation 

taken by the corporation was proper because the assets were not 

abandoned and continued to be held for the production of income. 

The Tax Court declined to decide these latter two issues, finding 

that the determination of the basic issue we have discussed 

earlier made a decision on the remaining issues unnecessary. We 

agree with that determination of the Tax Court and likewise find 

it unnecessary to treat the additional two issues. 

Accordingly, the decisions of the United States Tax Court are 

AFFIRMED. 

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Appellate Case: 89-9015 Document: 010110097371 Date Filed: 11/18/1991 Page: 9