TAX COURT OPINION

Case: Mark O. Kaplan
Docket Number: 3624-04
Judge: Thornton
Opinion Type: memo
Filed: 09/20/2005
Pages: 7

T. C. Memo. 2005-218 UNITED STATES TAX COURT MARK O. KAPLAN, Petitioner v. -COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 3624-04. Filed September 20, 2005. Albert L. Grasso, for petitioner. Kathleen C. Schlenzig, for respondent. MEMORANDUM OPINION THORNTON, Judge: Respondent determined a $123,543 deficiency with respect to petitioner's 1994 income tax and a $188,964 deficiency with respect to petitioner's 1997 income tax. The deficiencies arise from respondent's denial of petitioner's asserted basis in his wholly owned S corporation, Marc Construction and Development Co. (Marc), which resulted in SERVED SEP 2 0 2005 - 3 - to petitioner's 1997 tax year. See sec. 1366(d)(2). Petitioner took certain steps, as described below, to attempt to create adjusted basis in Marc to enable him to deduct the Marc loss in 1997. Petitioner Borrows $800,000 From the Bank On December 29, 1997, petitioner borrowed $800,000 from Manufacturers Bank (the Bank), evidenced by his promissory note (the note) of the same date. The note's maturity date was January 30, 1998. When he executed the note, petitioner prepaid $1,000 of finance charges to the Bank. When he applied for the loan, petitioner did not provide the Bank any financial statement, and he had no preexisting (cid:16)042relationship with the Bank. The note was collateralized by two Bank deposit accounts (the deposit accounts), one owned by Lakeview and the other owned by Pleasant Prairie. The deposit accounts were opened for the sole purpose of facilitating the e loan between petitioner and the Bank. When petitioner executed the note, the deposit accounts had zero balances. Petitioner Pays $800,000 to Marc Contemporaneously with the Bank loan, petitioner issued Marc an $800,000 check drawn on his account at the Bank. Marc deposited the check in its account at the Bank. Items Reallocated.From Silver .Glen!to Marc by(cid:16)042JournalEntry As of December:317 199.7 Marcós books;ande records showed "Loans° to :stockholders"mof Ál, 305, 226.. - pThis , amount jncluded, in . addition to,the $:800 000 Bank loanoproceeds-, hat petitioner. , . transferred to Marc on December .2.9 .199:7 ·(and29ertain nongermane items),0$21*3 571sthat.had-.been recorded3by Silver.Glen and that3,- was madelup rof $159,116!ofdle-gala.fees and-a.$49,000 loan from petitio'nèr. By.radjusting jour:nal4 entry,- these, amounts h td been "realloäat'ed" * f roms Silvera Glen; to Marc; as loans .from pe titioner . Merger of MaräpLa'keviewr and Pleasant -Prairi.e ur . On or about December 15, 1998, pursuant to section 368 (a) (1) (A).y Marc,[ Lakeview, and .Pleasant Praisi-e.merged into Marc Development Cornpany, a. C corporationipholly owned by petitioned. It t a v.. ùc . Petitioner' s 1997 Tax' Return and NOL Carryback to 1994 On his 1991 Federal sincome.. tax yeturn,, pe_titioner reported current-year fordt ary .iríconte;-from,·Marc -of. $183, 89p, which he of fset agdinst the $192, 752 Marc loss! tha;t, had. 1;>een. carried over from 1996 pursuant to section 1366-(d) (2) . Con-sequently, for 1997 petitioner reported a net loss from Marc of $608, 858. On Schedule D, -Capital Gains and(cid:16)042Losses, of his 1997 income f tax retürn; petitioner reporféd an$49,0.00 ,long-termqcapital gain from "Recapture lof Loan.Basis" with respect to the Silver Glen loan 4tliat.had ,beèn d'reallocated"3(as . discussed above) by C claim for increased basis resulting from these transactions. Id. Affirming this Court's decision, the Court of Appeals for the Eighth Circuit agreed that the taxpayer's loans to his S corporations involved no actual economic outlays. Oren v. Commissioner, 357 F..3d at 858-859. Similarly, petitioner's purported loan to Marc involved no actual economic outlay. In this case, as in Oren v. Commissioner, T.C. Memo. 2002-172, the various disbursements between the taxpayer and his S corporations were "the equivalent of offsetting bookkeeping entries, even though they occurred in the form of checks". The loan proceeds originated and ended with the Bank. The Bank loan was "collateralized" with $800,000 that (cid:16)042Lakeview and Pleasant Prairie deposited in their Bank accounts contemporaneously with the Bank loan. In effect, then, the Bank loan proceeds constituted the collateral for the Bank loan. As far as the record reveals, the loan proceeds never left the Bank (cid:16)042in the 11 days between the time the note was created and the time it was paid off.° 9 We are mindful that there was a note evidencing the Even if we were to assume, that there was a bona fide loan between the Bank and $800,000 loan from the Bank and that petitioner prepaid $1,000 in interest charges to the Bank. however, petitioner, whether petitioner made any actual economic outlay to Marc. Indeed,.petitioner has conceded that most of transaction was a "circular loan" that created no basis in Marc for petitioner. acknowledges that this circumstance would not answer the question of the $800,000 In making this concession, petitioner implicitly the bona fides of the Bank loan are not (continued...) "loan" to Marc and thereby was exposed to the risk of repaying $204,222 of the Bank loan from his own pocket. Any such risk to petitioner was illusory. In the first instance, by virtue of Pleasant Prairie's and Lakeview's depositing (cumulatively) the entire $800,000 of the Bank loan proceeds into their Bank accounts contemporaneously with the Bank's making the loan, there was no significant risk that the Bank would enforce payment against petitioner in the event of a default. Moreover, inasmuch as petitioner wholly owned and controlled these S corporations and their bookkeeping, they obviously were not going to act adversely to his interests. In any event, as a result of the December 15, 1998, merger of Marc, Lakeview, and Pleasant Prairie into a new C corporation wholly owned by petitioner, all purported loan obligations between petitioner and his S corporations were extinguished; i.e., after the merger, petitioner purportedly would have owed the new corporation $800,000, which would have been exactly offset by the $800,000 that the new corporation purportedly would have owed petitioner. These circumstances further denote "the inherent lack of substance in the loans." Oren v. Commissioner, T.C. Memo. 2002- 172. In sum, we envision no realistic scenario in which petitioner's purported loan to Marc would have or could have made him poorer. We hold and conclude that petitioner made no a loan to petitioner, and whether petitioner ever contributed $49,000 to Marc. The parties have stipulated that the books and records of Silver Glen and Marc indicate that a $49,000 loan from petitioner to Silver Glen was "reallocated" by adjusting journal entry from Silver Glen to Marc, which then included this amount in its "Loans to stockholders" account. Petitioner has not introduced any evidence, such as canceled checks or bank statements, to show that he actually disbursed $49,000 of his own funds to Silver Glen. As previously indicated, mere adjusting journal entries among petitioner's wholly owned S corporations are inadequate to establish that petitioner has made an actual economic outlay to Marc. Moreover, insofar as the record reveals, Marc's purported assumption of Silver Glen's purported debt was not accompanied by a novation releasing Silver Glen from liability to petitioner. Accordingly, if Marc failed to pay the purported debt, petitioner presumably would have had recourse against Silver Glen; the continued existence of petitioner's rights against Silver Glen negates creation of basis in Marc with respect to the purported debt. See Hitchins v. Commissioner, 103 T.C. at 717-719. On his 1997 Federal income tax return, petitioner reported a $49,000 long-term capital gain from "Recapture of Loan Basis" with respect to the Silver Glen loan. At most, this tax reporting might tend to corroborate petitioner's claim that - 17 - explanation as to why the expenses should have been recorded by Silver Glen, if they were paid by petitioner personally on behalf of Marc. We conclude and hold that petitioner has failed to prove that he is entitled to any basis in Marc with respect to the alleged legal expense. VI. Conclusion Petitioner has failed to establish that as of December 31, 1997, he had adjusted basis in Marc greater than the $321,859 that respondent has conceded. Accordingly, pursuant to section 1366(d), petitioner's 1997 loss deductions from Marc are limited to $321,859. To reflect respondent's concession, Decision will be entered under Rule 155.