[PUBLISH]

IN THE UNITED STATES COURT OF APPEALS

FOR THE ELEVENTH CIRCUIT

________________________

No. 18-11909

________________________

Agency No. 001795-13

HOMERO F. MERUELO, 

 Petitioner-Appellant,

versus

COMMISSIONER OF INTERNAL REVENUE, 

 Respondent-Appellee.

________________________

Petition for Review of a Decision of the

United States Tax Court

________________________

(May 6, 2019)

Before WILLIAM PRYOR and NEWSOM, Circuit Judges, and VRATIL,

* District

Judge.

WILLIAM PRYOR, Circuit Judge: 

 * Honorable Kathryn H. Vratil, United States District Judge for the District of Kansas, sitting by 

designation.

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This appeal from the disallowance of a taxpayer’s claimed deduction for his 

share of losses suffered by an S corporation presents the following issue: whether 

monetary transfers between various business entities partly owned by the taxpayer 

and an S corporation that were later reclassified as loans from the taxpayer to the S 

corporation established a “bona fide indebtedness” that “runs directly” to the 

taxpayer. Treas. Reg. § 1.1366-2(a)(2)(i); see also 26 U.S.C. § 1366. Homero

Meruelo was a shareholder of Merco of the Palm Beaches, Inc., which suffered a

nearly $27 million loss after banks foreclosed on its condominium complex.

Meruelo asserted that he had a sufficient basis in Merco’s indebtedness for him to 

deduct $13 million as his share of the loss. Meruelo claimed basis from a $5 

million capital contribution he made to Merco and more than $9 million of 

indebtedness from net transfers through various other business entities in which he 

held an interest. The Internal Revenue Service determined that he could claim only

the $5 million basis and not the $9 million because any debt ran from Merco to the 

other entities. The Tax Court later ruled that Meruelo had failed to establish a bona 

fide indebtedness of $9 million running directly to him and that he failed to 

establish that he made an “actual economic outlay” toward the debt. Because the 

Tax Court correctly determined that Meruelo did not establish a bona fide 

indebtedness that ran directly to him, we affirm.

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I. BACKGROUND

Meruelo, a real estate developer in south Florida, owns interests in several S 

corporations, partnerships, and limited liability companies. One of these entities 

was Merco of the Palm Beaches, Inc., an S corporation Meruelo incorporated in 

March 2004. Meruelo held 49 percent of Merco’s stock. 

Subchapter S of the Internal Revenue Code provides “a pass-through system 

under which corporate income, losses, deductions, and credits are attributed to 

individual shareholders in a manner akin to the tax treatment of partnerships.” 

Buffered v. Comm’r, 506 U.S. 523, 525 (1993). A shareholder’s ability to deduct 

his proportionate share of a corporation’s net operating losses is limited by the sum 

of his basis in his stock and the corporate indebtedness to him. See 26 U.S.C. 

§ 1366(d)(1). In other words, the shareholder can increase his basis by contributing 

capital to the corporation or by lending money to it. 

Meruelo incorporated Merco to purchase a condominium complex in a 

bankruptcy sale. In early 2004, the bankruptcy court approved the sale and 

required Merco to pay a $10 million non-refundable deposit to secure the property. 

To raise funds for his share of the deposit, Meruelo obtained a personal loan. 

Meruelo transferred $4,985,035 of the loan proceeds to Merco Group at 

Akoya, an S corporation in which he and his mother each held a 50 percent

interest. In March 2004, Akoya transferred into Merco’s escrow account $5 

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million—$4,985,035 of Meruelo’s loan proceeds and $14,965 of Akoya’s own 

funds—to cover half the required deposit. Akoya had also previously transferred to 

Merco enough funds to cover the $5 million balance of the deposit. The 

Commissioner does not dispute that the $4,985,035 transfer gave Meruelo a 

shareholder basis in that amount in Merco. 

From 2004 to 2008, Merco entered into hundreds of transactions with 

various partnerships, S corporations, and limited liability companies in which 

Meruelo held an interest. These Merco affiliates often paid expenses, such as 

payroll costs, for each other or for Merco to simplify accounting and enhance 

liquidity. The payor company recorded these payments to its affiliates as accounts 

receivable, and the payee company recorded them as accounts payable. Between

2004 and 2008, Merco affiliates made more than $15 million in payments to or on 

behalf of Merco, and Merco repaid its affiliates less than $6 million of these 

payments. On December 31 of each year, Merco’s books and records showed 

substantial net accounts payable to its affiliates. 

Luis Carreras, a certified public accountant, prepared the tax returns filed by 

Meruelo, Merco, and the Merco affiliates. When preparing Merco’s tax return for a 

given year, Carreras would net Merco’s accounts payable to its affiliates, as shown 

on Merco’s books as of the preceding December 31, against Merco’s accounts 

receivable from its affiliates. If Merco had net accounts payable, Carreras reported 

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that amount as a “shareholder loan” on Merco’s tax return. Carreras then allocated 

a percentage of this indebtedness to Meruelo based on Meruelo’s ownership 

interests in the various affiliates that had transferred funds to Merco. 

In March 2004, Carreras drafted a promissory note for Meruelo purportedly

to make a $10 million unsecured line of credit available to Merco at a six percent

interest rate. Carreras testified that, when he prepared Meruelo’s and Merco’s tax 

returns for tax years 2004 to 2008, he made an annual charge to Merco’s line of 

credit for an amount equal to Meruelo’s calculated share of Merco’s net accounts 

payable to its affiliates for the preceding year. 

In 2008, Merco incurred a loss of $26,605,840 when banks foreclosed on the 

condominium complex it purchased in 2004. Merco reported this loss on its 

income tax return, and Merco allocated 49 percent of the loss to Meruelo. 

Meruelo filed income tax returns for 2005 and 2008. On his 2005 return, he 

reported taxable income of $13,895,731 and tax due of $4,843,976. On his 2008 

return, he claimed an ordinary loss deduction of $11,795,109. This deduction 

reflected a $13,036,861 flow-through loss from Merco ($26,605,840 × 49 percent) 

netted against gains of $1,241,752 from two other S corporations in which he held 

interests. After accounting for other income and deductions, Meruelo reported a net 

operating loss of $11,793,865 on his 2008 return. In October 2009, he applied for a 

tentative refund asserting a net operating loss carryback of $11,793,865 from 2008

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to 2005. After applying this net operating loss carryback, his original tax lability 

for 2005, $4,843,976, was reduced by $3,897,470, to $946,506. In January 2010, 

the Internal Revenue Service issued Meruelo a refund of $3,897,470. 

The Internal Revenue Service selected Meruelo’s 2005 and 2008 returns for 

examination. It determined that his basis in Merco was only $4,985,035 based on 

the proceeds of the bank loan that Meruelo contributed to Merco through Akoya. It 

disallowed, for lack of a sufficient basis, $8,051,826 of the $13,036,861 flowthrough loss claimed for 2008. 

After disallowing part of the net operating loss for 2008, the Commissioner 

determined that Meruelo’s carryback to 2005 was limited to $3,706,272 and that 

his correct tax due for 2005 was $3,546,781. Because Meruelo had reported a tax 

liability of only $946,506 for 2005, the Commissioner concluded that Meruelo’s 

tax deficiency for that year was $2,600,275 and sent Meruelo a notice of 

deficiency. 

Meruelo petitioned the Tax Court for redetermination of his tax deficiency. 

He alleged that he had a sufficient basis in Merco for him to fully deduct his share 

of its 2008 losses. Meruelo alleged that his basis in Merco consisted of $2.7 

million of Akoya’s first deposit of $5 million, all $5 million of Akoya’s second 

deposit, and $6,616,857 for his share of intercompany transfers. 

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Meruelo offered two theories to claim credit for the affiliated companies’ 

transfers to Merco: the “back-to-back loan” theory and the “incorporated 

pocketbook theory.” Under the back-to-back-loan theory, he argued the affiliated 

companies should have been treated as lending funds to him that he then lent to 

Merco. And under the incorporated-pocketbook theory, Meruelo argued that he 

should have been treated as using his funds, which were held by the affiliated 

companies, to pay Merco’s expenses on his behalf. 

After a trial, the Tax Court ruled for the Commissioner. The Tax Court 

acknowledged that Meruelo had an undisputed basis of $4,985,035 in Merco, and it 

explained that only $8,051,826 of the $13,036,9861 flow-through loss was in 

dispute. But the Tax Court determined that Meruelo was not entitled to any of the 

disputed basis. 

The Tax Court explained that section 1366(d)(1)(B) of the Internal Revenue 

Code allows a shareholder to increase his basis by the amount of the adjusted basis 

of any indebtedness owed by the S corporation to the shareholder. Because the 

Code “does not specify how a shareholder may acquire basis in an S corporation’s 

indebtedness to him,” the Tax Court turned to the legislative history of the 

predecessor to section 1366 for guidance. The Tax Court explained that earlier

decisions relied on this legislative history and construed language about “a 

shareholder’s investment in a corporation” to require an “actual economic outlay” 

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by the shareholder. In other words, the Tax Court ruled that a shareholder must 

show that he incurred a cost in making a loan or that he was left poorer in a 

material sense after the transaction. 

The Tax Court decided that the test for determining a shareholder’s basis in 

an S corporation under Treasury Regulation § 1.1366-2(a)(2)—which was 

amended in 2014 and limits debt basis to “bona fide indebtedness of the S 

corporation that runs directly to the shareholder”—was effectively the same as that 

under the “actual economic outlay” doctrine. The Tax Court explained that it had 

long required that a shareholder prove an S corporation’s indebtedness running 

directly to him to deduct his proportionate share of the corporation’s net operating 

loss. And the Tax Court reasoned that because the 2014 regulation states that 

“bona fide indebtedness” is to be determined by “general Federal tax principles,” 

the 2014 regulation incorporates the actual economic outlay doctrine. 

The Tax Court rejected Meruelo’s back-to-back-loan theory because there 

was no evidence that funds had been lent to Meruelo and then lent back to Merco. 

The Tax Court acknowledged that bona fide back-to-back loans, first from an 

affiliated company to a shareholder and then from the shareholder to the debtor S 

corporation, can increase a shareholder’s basis. But it explained that a shareholder 

is bound by the form of the transaction he initially chose and that transactions 

directly among related companies (and not involving the shareholder) do not 

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qualify as back-to-back loans. The Tax Court clarified that a taxpayer-shareholder 

cannot reclassify intercompany loans as shareholder loans for tax purposes when 

preparing his return. The Tax Court then ruled that, because there was no evidence 

that the Merco affiliates had contemporaneously booked transfers between them as 

shareholder loans—the affiliates instead labeled them as accounts receivable and 

payable, wage payments, or capital contributions—Meruelo’s back-to-back-loan 

theory failed. The Tax Court also ruled that, because Meruelo made no actual 

economic outlay toward the monetary transfers from the Merco affiliates to Merco, 

he could not claim that these transfers amounted to a shareholder loan.

The Tax Court likewise rejected Meruelo’s incorporated-pocketbook theory. 

The Tax Court explained that, although some of its rulings allowed basis increases 

under an incorporated-pocketbook theory, the facts here were a “far cry” from

those decisions. The Tax Court explained that in other incorporated-pocketbook 

decisions, the taxpayer habitually used a single, wholly owned corporation to pay 

third parties on his behalf. But many of the Merco affiliates had co-owners besides 

Meruelo, and Meruelo had not shown that these affiliates had a “habitual practice” 

of paying his personal expenses. And the Tax Court explained that the 

“incorporated pocketbook” corporations contemporaneously booked the 

disbursements as shareholder loans. The Merco affiliates, by contrast, booked their 

transactions as capital contributions, payroll expenses, or intercompany accounts 

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payable and receivable, and only relabeled the disbursements as shareholder loans 

at the close of each year. The Tax Court upheld the Commissioner’s determination 

of a $2,600,275 deficiency.

II. STANDARD OF REVIEW

We “review the decisions of the Tax Court . . . 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(a)(1). “The interpretation of a statutory section of the 

Internal Revenue Code by the tax court is a question of law reviewed de novo.”

McLaulin v. Comm’r, 276 F.3d 1269, 1272 (11th Cir. 2001).

III. DISCUSSION

Section 1366 permits a shareholder of an S corporation to deduct his pro 

rata share of a net operating loss sustained by the corporation:

(a) Determination of shareholder’s tax liability.—

(1) In general.—In determining the tax under this chapter of a 

shareholder for the shareholder’s taxable year in which the 

taxable year of the S corporation ends . . . , there shall be taken 

into account the shareholder’s pro rata share of the 

corporation’s—

(A) items of income (including tax-exempt income), loss,

deduction, or credit the separate treatment of which could 

affect the liability for tax of any shareholder, and

(B) nonseparately computed income or loss.

. . . 

(d) Special rules for losses and deductions.—

(1) Cannot exceed shareholder’s basis in stock and debt.—

The aggregate amount of losses and deductions taken into 

account by a shareholder under subsection (a) for any taxable 

year shall not exceed the sum of—

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(A) the adjusted basis of the shareholder’s stock in the S 

corporation . . . , and

(B) the shareholder’s adjusted basis of any indebtedness 

of the S corporation to the shareholder . . . . 

26 U.S.C. § 1366. Under section 1366(a)(1), an S corporation’s income and 

operating losses are passed through to its shareholders in a similar way to the tax 

treatment of partnerships. Buffered, 506 U.S. at 525; Ellinger v. United States, 470 

F.3d 1325, 1329 n.2 (11th Cir. 2006). A shareholder may deduct his portion of an 

S corporation’s net operating losses only to the extent that the loss does not exceed 

the sum of “the adjusted basis of the shareholder’s stock in the S corporation,” 26 

U.S.C. § 1366(d)(1)(A), and “the shareholder’s adjusted basis of any indebtedness 

of the S corporation to the shareholder,” id. § 1366(d)(1)(B). This appeal concerns 

only a shareholder’s adjusted basis of indebtedness under section 1366(d)(1)(B). 

Meruelo argues, and the Commissioner agrees, that the governing

regulation, Treas. Reg. § 1.1366-2, as amended in 2014, provides a standard of 

“bona fide indebtedness” that must run “directly to the shareholder” for 

determining a shareholder’s debt basis in an S corporation: 

(2) Basis of indebtedness—(i) In general. The term basis of any 

indebtedness of the S corporation to the shareholder means the 

shareholder’s adjusted basis . . . in any bona fide indebtedness of the S 

corporation that runs directly to the shareholder. Whether indebtedness 

is bona fide indebtedness to a shareholder is determined under general 

Federal tax principles and depends upon all of the facts and 

circumstances.

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Treas. Reg. § 1.1366-2(a)(ii)(2) (emphasis added). The Commissioner also agrees 

that this regulation applies to Merco’s losses for the 2005 and 2008 tax years 

because those tax years were still open for assessment in July 2014. See id. § 

1.1366-5(b) (explaining that the regulation applies “with respect to indebtedness 

between an S corporation and its shareholder that resulted from any transaction 

that occurred in a year” that was still open for assessment on July 23, 2014).

An S corporation’s debt does not run directly to the shareholder if it instead 

flows through “an entity with passthrough characteristics which advanced the 

funds and is closely related to the taxpayer.” Hitchins v. Comm’r, 103 T.C. 711, 

715 (1994). But the 2014 regulation provides that if a shareholder engages in 

genuine “back-to-back” loans—in which an affiliated entity loans the shareholder 

funds that he then loans directly to the S corporation—those loans can establish 

bona fide indebtedness running directly to the shareholder. See Treas. Reg. 

§ 1.1366-2(a)(2)(iii) (“Example 2. Back-to-back loan transaction. A is the sole 

shareholder of two S corporations, S1 and S2. S1 loaned $200,000 to A. A then 

loaned $200,000 to S2 . . . If A’s loan to S2 constitutes bona fide indebtedness 

from S2 to A, A’s back-to-back loan increases A’s basis of indebtedness in 

S2 . . . .”). So to claim a deduction under section 1366(a), Meruelo had to establish 

that a bona fide indebtedness of Merco ran directly to him.

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Meruelo presents two alternative arguments that the Tax Court erred in 

disallowing his deduction. First, he contends that Merco’s debt ran directly to him 

under a back-to-back-loan theory. Second, he contends that the debt ran directly to 

him under an incorporated-pocketbook theory. Both arguments fail.

A. Meruelo’s Back-to-Back-Loan Theory Fails Because Merco’s Debt Ran to 

the Merco Affiliates, Not to Meruelo.

Meruelo argues that he can claim a debt basis based on his back-to-backloan theory for two reasons. First, he argues that we should treat the monetary 

transfers between the Merco affiliates as back-to-back loans based on the economic 

substance of the transactions rather than the form they took. Second, he

alternatively contends that the form of the transactions was sufficient to establish 

that they amounted to back-to-back loans.

Meruelo’s argument for substance over form is a nonstarter. Taxpayers are 

ordinarily “liable for the tax consequences of the transaction they actually execute 

and may not reap the benefit of some other transaction that they might have made.” 

Selfe v. United States, 778 F.2d 769, 773 (11thCir. 1985). “In other words, 

taxpayers ordinarily are bound by the ‘form’ of their transaction and may not argue 

that the ‘substance’ of their transaction triggers different tax consequences.” Id.

The Supreme Court has explained that although “a taxpayer is free to organize his 

affairs as he chooses, nevertheless, once having done so, he must accept the tax 

consequences of his choice, whether contemplated or not, and may not enjoy the 

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benefit of some other route he might have chosen to follow but did not.” Comm’r 

v. Nat’l Alfalfa Deyhdrating & Milling Co., 417 U.S. 134, 149 (1974) (citations 

omitted). 

The parties cite, and we are aware of, only a single decision in which we 

have agreed with a taxpayer that an exceptional circumstance could warrant 

looking to the substance of a transaction instead of its form as having a different 

tax consequence. See Selfe, 778 F.2d at 774. The taxpayer-shareholder in Selfe had 

initially obtained a loan in her individual capacity to fund her fledgling retail 

clothing business and pledged her personal assets as collateral. See id. at 770. At 

the bank’s request, she agreed to convert her loan into one from the bank to the S 

corporation where she guaranteed the corporation’s indebtedness to the bank and 

continued to pledge her assets as collateral. Id. at 770–71. We concluded that, in 

the light of the circumstances suggesting that the bank looked to the shareholder as 

the primary obligor on the loan instead of the thinly capitalized S corporation, 

genuine issues of material fact existed as to whether the guaranteed loan was 

effectively a back-to-back loan through the shareholder. Id. at 774–75. We 

remanded to determine whether the shareholder’s guaranty amounted to either a 

shareholder loan or an equity investment. Id. at 775.

Nothing akin to the exceptional circumstance in Selfe occurred here. Only an 

“unusual set[] of facts” can warrant judging a transaction based on its substance 

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instead of its form. Sleiman v. Comm’r, 187 F.3d 1352, 1359 (11th Cir. 1999)

(refusing to extend the approach from Selfe to treat a shareholder-guaranteed loan 

to an S corporation as if it were a back-to-back loan where the lender looked to the 

shareholder as only a secondary obligor). Meruelo’s argument about the substance 

of his transaction—that a portion of the funds the affiliates transferred to Merco 

could be considered profits that Meruelo was otherwise entitled to receive and that 

the funds were used to pay Merco’s business expenses—hardly presents an 

“unusual set of facts” about intercompany monetary transfers, and it does not 

justify setting aside our ordinary rule that the taxpayer is bound by the form his 

transactions. See Shebester v. Comm’r, 53 T.C.M. (CCH) 824 (1987) (rejecting 

taxpayer’s contention that loans from one controlled S corporation to another 

controlled S corporation were in substance a series of dividends to the shareholder 

from one corporation followed by loans from the shareholder to the other 

corporation). 

Meruelo also argues that his accountant’s end-of-year reclassification of the 

intercompany transfers, as reflected on his tax returns and on the annual 

adjustments to the line-of-credit from the 2004 Note, were sufficient to establish 

that the transactions amounted to shareholder, but we disagree. “After-the-fact 

reclassification cannot satisfy the requirement that the debt run directly from the S 

corporation to the taxpayer/shareholder, and courts have previously rejected efforts 

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by taxpayers to establish debt basis in an S corporation using this method.” Broz v. 

Comm’r, 727 F.3d 621, 627 (6th Cir. 2013); Ruckriegel v. Comm’r, 91 T.C.M. 

(CCH) 1035 (2006) (ruling that yearend reclassification of intercorporate loans as 

back-to-back loans through the taxpayer was insufficient to provide debt basis);

Burnstein v. Comm’r, 47 T.C.M. (CCH) 1100 (1984) (same). Because the 

transactions were contemporaneously classified as transactions between the 

affiliates and Merco, the designation Meruelo’s accountant gave them at the end of 

the year does not govern. And we agree with the Tax Court that the accountant’s 

adjustments to “a notional line of credit, uniformly made after the close of each 

relevant tax year, do not suffice to create indebtedness to [Meruelo] where none in 

fact existed.” 

B. Meruelo’s Incorporated-Pocketbook Theory Fails Because the Merco 

Affiliates Were Not His Incorporated Pocketbook. 

Meruelo alternatively contends that he can claim debt basis based on his

incorporated-pocketbook theory. This theory holds that “[a] taxpayer can obtain 

debt basis in an S corporation through payments made by a wholly owned 

corporate entity if that entity functions as the shareholder’s ‘incorporated 

pocketbook,’ meaning that the taxpayer has a ‘habitual practice of having his 

wholly owned corporation pay money to third parties on his behalf.’” Broz, 727 

F.3d at 627–28 (citation omitted). In two decisions, the Tax Court has ruled that 

payments made to an S corporation by a taxpayer’s “incorporated pocketbook” 

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company were sufficient to establish the shareholder’s debt basis. See Yates v. 

Comm’r, 82 T.C.M. (CCH) 805 (2001); Culnen v. Comm’r, 79 T.C.M. (CCH) 

1933 (2000), rev’d on other grounds, 28 F. App’x 116 (3d Cir. 2002).

Even if we assume that the incorporated-pocketbook theory comports with 

the requirement that a debt run “directly to the shareholder,” Meruelo failed to 

establish that the Merco affiliates constituted his incorporated pocketbook. Unlike 

the shareholders in Yates and Culnen—who used a single, wholly owned entity to 

pay third parties on the shareholder’s behalf—Meruelo seeks to treat eleven 

distinct Merco affiliates, many of which he only partially owned, as his 

incorporated pocketbook. Many of the Merco affiliates acted more like ordinary 

business entities than as incorporated-pocketbook companies because they both 

disbursed and received funds for business expenses from Merco. As the Tax Court

explained, no court has ever ruled that a group of non-wholly owned entities that 

both receive and disburse funds in this fashion can constitute an incorporated 

pocketbook. And Meruelo failed to establish that he habitually paid third parties on 

his behalf through the putative incorporated-pocketbook companies. Meruelo’s 

evidence established only that the Merco affiliates regularly paid the expenses of 

other companies within the affiliate group—not his personal expenses. See Broz, 

727 F.3d at 628 (affirming Tax Court’s rejection of taxpayers’ “incorporated 

pocketbook” argument where the taxpayers failed to establish that they habitually 

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paid third parties through the entities); Messina v. Comm’r, 114 T.C. Memo. 2017-

213, at *32–33 (2017) (rejecting theory on the same ground); Ruckriegel, 91 

T.C.M. (CCH) 1035 (same).

IV. CONCLUSION

We AFFIRM the judgment of the Tax Court in favor of the Commissioner. 

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