TAX COURT OPINION

Case: William H. Maloof
Docket Number: 17951-03
Judge: Kroupa
Opinion Type: memo
Filed: 04/06/2005
Pages: 8

s.r. Junoz T.C. Memo. 2005-75 UNITED STATES TAX COURT WILLIAM H. MALOOF, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 15211-02, 17951-03. Filed April 6, 2005. Donald J. O'Connor, for petitioner. Anita A. Gill, for respondent. MEMORANDUM FINDINGS OF FACT AND OPINION KROUPA, Judoe: Respondent determined deficiencies in petitioner's Federal income tax by disallowing operating losses sustained by an S corporation in which petitioner was the sole shareholder. After concessions, the sole issue before the Court is whether petitioner is entitled to increase his adjusted basis in the S corporation by $4 million, the amount of a loan a third SERVED .APR 6 2005 - 3 - loan involved here is a $4 million loan2 from Provident Bank (the bank) pursuant to a loan agreement dated July 29, 1993. The $4 million loan consisted of three principal components, each collateralized differently. First, there was a $750,000 equipment note that was secured by equipment Level Propane would purchase with the loan proceeds. Second, there was a $2.5 million revolving term loan that was secured by petroleum tanks and supply contracts Level Propane owned. Third, there was a $750,000 demand loan that was secured by the inventory and accounts receivable of Level Propane. As additional collateral for the $4 million loan to Level Propane, petitioner pledged all the shares he owned of Level Propane and a $1 million life insurance policy on his life. Level Propane made monthly interest payments on the $4 million loan through an account that Level Propane was required to maintain with the bank. Petitioner made no payments on the loan. Level Propane defaulted on the loan and was forced into involuntary bankruptcy. At no time did the bank demand payment from petitioner individually or begin collection action against petitioner regarding the $4 million loan to Level Propane. 2During his testimony, petitioner briefly referred to approximately $60 million in loans. Petitioner failed to introduce any evidence, however, the $4 million loan from Provident Bank. to document any loans other than of the $4 million loan. We must therefore determine whether petitioner may increase his basis in the S corporation by the amount of the $4 million loan so petitioner may deduct passthrough operating losses of the S corporation. OPINION Petitioner and respondent differ on the effect of the $4 million loan the bank made to Level Propane. Petitioner argues that he is entitled to increase his basis in the stock of Level Propane by the amount of the loan for three reasons. First, petitioner argues that he is entitled to an increase in basis in Level Propane because he personally guaranteed the loan. Second, petitioner argues that he is entitled to increase his basis in Level Propane because he pledged stock to secure the loan. Regarding this second argument, petitioner implies that Eleventh Circuit precedent compels a different result from our own caselaw. .Third, petitioner argues that he is entitled to . increase his basis in Level Propane because he incurred a cost when he lost "control" of Level Propane. Respondent counters that neither petitioner's guaranty, the pledged stock, nor the bank's "control" over Level Propane constituted an economic outlay. Respondent also argues that Eleventh Circuit caselaw does.not compel a different result. We address the parties' contentions in turn. First, we state the general rules governing when a shareholder of an S - 7 - applies because the disallowed amount exceeds the shareholder's economic investment in the S corporation and, because of the limited liability accorded to S corporation shareholders, the amount does not have to be repaid. The disallowed losses and deductions may be carried forward iñdefinitely, however, and claimed when and to the extent that the shareholder increases his or her basis in the S corporation.6 See sec. 1366(d) (2). Economic Outlay A taxpayer must make an economic outlay for a loan to create basis. A taxpayer makes an economic outlay when he or she incurs a "cost"? on a third-party loan or is left poorer in a material sense after the transaction. Putnam v. Commissioner, 352 U.S. 82 (1956); Estate of Bean v. Commissioner, 268 F.3d 553, 558 (8th Cir. 2001), affg. T.C. Memo. 2000-355; Bergman v. United States, 174 F.3d 928, 930 n.6 (8th Cir. 1999); Estate of Leavitt v. Commissioner, 875 F.2d 420, 422 (4th Cir. 1989), affg. 90 T.C. 206 (1988); Brown v. Commissioner, 706 F.2d 755, 756 (6th Cir. 1983), affg. T.C. Memo. 1981-608; Spencer v. Commissioner, 110 T.C. 62, 83-84 (1998), affd. without published opinion 194 E.3d 6Shareholders may increase basis in an S corporation by capital contributions, stock purchases, or extensions of additional credit, or where the S corporation generates taxable income. 'Basis of property is the "cost" of the property. Sec. 1012. cash or other property." "Cost" is defined as the "amount paid" for property "in Sec. 1.1012-1(a), Income Tax Regs. _ 9 _ the guaranty to increase basis in the S corporation.8 Perry v. Commissioner, 392 F.2d 458 (8th Cir. 1968) (corporate debts guaranteed by the shareholder were not debt whose basis is taken into account for loss passthrough purposes). But see Selfe v. United States, supra (sole shareholder may get a basis increase in stock if the loan was in fact made to him or her and borrowed funds were re-lent to corporation). Cf. Estate of Leavitt v. Commissioner, 90 T.C. 206 (1988) (no basis increase for shareholder-guaranteed loan to corporation; majority refused to apply debt-equity principles to S corporation's guaranteed loan, rejecting Selfe). The shareholder in an S corporation therefore, generally, may not increase his or her basis in the S corporation by simply guaranteeing the debt of an S corporation. Because petitioner was not called upon to perform under the loan or make any payment, we hold that his personal guaranty did not increase his basis in Level Propane. Pledged Collateral We next address whether petitioner's pledge of stock of an S corporation to secure the loan the bank made to the S corporation constitutes an economic outlay. We address, first, our caselaw, eBy contrast, a limited partner who guarantees a nonrecourse partnership debt may be allowed to increase basis. - 11 - distinguishable from the facts before us, and, hence, that case is not controlling. We first note that the court in Selfe reaffirmed the principle that "an economic outlay is required" before a shareholder in an S corporation may increase his or her basis. Selfe v. United States, supra at 772. Selfe holds, however, that a shareholder ~does not, in all circumstances, have to "absolve" a corporation's debt to increase basis. Id. (citing Brown v. Commi.ssioner, 706 F.2d 755 (6th Cir. 1983)). Selfe does not compel a different conclusion, notwithstanding its holding, because our facts are distinguishable. In Selfe, the taxpayer borrowed funds in her individual capacity, then pledged her personal assets as collateral for a loan. Id. at 770. The taxpayer later formed an S corporation and advanced the borrowed funds to the S corporation. Id. The taxpayer's loan was, at that point, converted into a loan to the corporation. The corporation assumed the liability to repay the loan, and the taxpayer guaranteed repayment if the corporation did not repay. The taxpayer's personal assets continued to be co.llateral for the corporate liability. Id. at 771. Petitioner has offered no evidence that he personally borrowed funds from the bank and then advanced those funds to Level Propane, or that the bank looked primarily to him for repayment. In contrast, a bank employee in Selfe testified that - 13 - not squarely on point and Golsen rule inapplicable), affd. 693 F.2d 459 (5th Cir. 1982); Golsen v. Commissioner, 54 T.C. 742, 756-757 (1970) (the Golsen rule requires the Court to follow a Court of Appeals decision that is squarely on point if appeal from its decision lies to that Court of Appeals), affd. 445 F.2d 985 (10th Cir. 1971). Loss of Control Petitioner makes a third argument for increasing his basis by the amount of the $4 million loan. Petitioner argues that he lost "control" of Level Propane and was thèrefore entitled to a basis increase by the amount of the cost he associated with losing control of the S corporation. Petitioner has not substantiated, however, any alleged loss of control. Nor has petitioner provided us with a means to value the loss of control. Even had petitioner substantiated some transitory loss of control, no basis-increasing event occurred. Petitioner remained at all times the owner of his shares. We conclude that petitioner has failed to show any economic outlay for his alleged loss of control. Form of the Transaction Finally, we address petitioner's argument that we recharacterize the form of the loan transaction as a loan to himself that he then advanced to Level Propane. Taxpayers are ordinarily bound by the "form" of their transaction and may not - 15 - passthrough losses from Level Propane. Accordingly, we sustain respondent's disallowance of those deductions during the years at issue. Decisions will be entered for respondent.