1996 Tax Ct. Memo LEXIS 450 | Tax Ct. | 1996
1996 Tax Ct. Memo LEXIS 450">*450 Decision will be entered under Rule 155.
MEMORANDUM OPINION
TANNENWALD,
The issues for decision are whether petitioners: (1) Are entitled to a passthrough loss from a wholly owned S corporation, and (2) are liable for an addition to tax pursuant to section 6661 for a substantial understatement of tax.
All of the facts have been stipulated. The stipulation of facts and attached exhibits are incorporated herein by this reference.
At the time their petition was filed, petitioners resided in New York, New York.
During 1987, Arun Bhatia (petitioner) was in the construction business1996 Tax Ct. Memo LEXIS 450">*451 and conducted his business through at least two entities, including Arun Bhatia Development Corporation (ABDC) and Ganbir Construction Corporation (GCC), both of which had elected subchapter S status for 1987. Petitioner was the sole shareholder and president of ABDC and GCC during 1987. At the beginning of 1987, petitioner's basis in ABDC was zero.
On October 26, 1987, petitioner executed a document captioned "Assumption Agreement" (assumption agreement), which stated in part: WHEREAS, BHATIA [petitioner] is the sole shareholder of ABDC; and, WHEREAS, ABDC is currently indebted to GANBIR CONSTRUCTION CORPORATION ("GCC") in the amount of $ 244,500.00; and, WHEREAS, BHATIA desires to assume ABDC's obligations to GCC so as to improve ABDC's capital structure; NOW, THEREFORE, in consideration of her [sic] premises [sic] and of the mutual covenants and agreements set forth herein, BHATIA makes the following undertakings and agreements: 1. BHATIA hereby undertakes, assumes and agrees to perform, pay or discharge when due, to the extent not heretofore performed, paid or discharged, all obligations of ABDC to GCC in the amount of $ 244,500.00. 2. It is expressly understood that 1996 Tax Ct. Memo LEXIS 450">*452 BHATIA is not hereby assuming, or agreeing to perform, pay or discharge any liability of ABDC other than the obligations specifically identified [sic] in paragraph 1 hereinabove. 3. The assumption of the obligations set forth in this ASSUMPTION AGREEMENT shall be construed as a valid obligation of ABDC to BHATIA in the amount of the obligation assumed. 45[sic] This ASSUMPTION AGREEMENT shall be interpreted in accordance of [sic] with the Laws of the State of New York and shall bind and enure to the benefit of the parties, their heirs, successors and assigns.
ABDC reported a net operating loss in the amount of $ 169,602 on its 1987 Form 1120S, U.S. Income Tax Return for an S Corporation. GCC reported net income1996 Tax Ct. Memo LEXIS 450">*453 of $ 256,572 on its 1987 Form 1120S. The following information was contained on GCC's Forms 1120S for 1987 and 1988, respectively:
Beginning | Ending | ||
Year | Item | Balance | Balance |
1987 | Trade notes and accounts receivable | $ 476,374 | $ 807,551 |
Accumulated adjustments account | (125,063) | 108,699 | |
1988 | Trade notes and accounts receivable | 563,051 | 1,849,370 |
Accumulated adjustments account | (135,801) | (172,891) |
On Schedule E of their 1987 Federal income tax return, petitioners: (1) Claimed a $ 169,602 passthrough loss from ABDC, and (2) $ 241,424 of passthrough income from GCC.
Section 1366(a) requires a taxpayer to take into account the pro rata share of income, losses, and deductions of an S corporation of which the taxpayer is a shareholder. The losses and deductions taken into account are limited as follows:
Sec. 1366(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-- (A) the adjusted basis of the shareholder's stock in the1996 Tax Ct. Memo LEXIS 450">*454 S corporation * * *, and (B) the shareholder's adjusted basis of any indebtedness of the S corporation to the shareholder * * *.
Prior cases have established certain principles in respect of the application of the indebtedness limitation under section 1366(d)(1)(B). See Eustice & Kuntz, Federal Income Taxation of S Corporations, sec. 9.05 at 9-47 through 9-54 (3d ed. 1993). 2 Most important to our analysis is the requirement that there be an actual economic outlay by the taxpayer. See
1996 Tax Ct. Memo LEXIS 450">*455 Petitioner contends that, by entering into the assumption agreement, he is entitled to increase his basis in ABDC in an amount corresponding to the amount of the obligation he assumed. Respondent counters that the assumption agreement was a "scheme" by which petitioner attempted to increase his basis in ABDC in order to enable him to utilize its net operating losses and that petitioner did not make the economic outlay required by the decided cases. Consequently, respondent asserts that petitioner is precluded from taking the ABDC net operating loss in 1987 because his basis in ABDC was zero.
In
In reaching its decision, the Court of Appeals for the Fifth Circuit discussed the focus of Congress at the time section 1374(c)(2)(B), the predecessor to section 1366(d)(1), see The amount of the net operating loss apportioned to any shareholder pursuant to the above rule is limited under section 1374(c)(2) to the adjusted basis of the shareholder's
The Court of Appeals then went on to conclude: In the transaction at issue in this case, the taxpayers in 1967 merely exchanged demand notes between themselves and their wholly owned corporation; they advanced no funds to either Lubbock or Albuquerque. Neither at the time of the transaction, nor at any other time prior to or during 1969 was it clear that the taxpayers would ever make a demand upon themselves, through Lubbock, for payment of their note. Hence, as in the guaranty situation, until they actually paid their debt to Lubbock in 1970 the taxpayers had made no additional investment in Albuquerque that would increase their adjusted basis in an indebtedness of Albuquerque to them within the meaning of section 1374(c)(2)(B). * * * [
Petitioners attempt to distinguish the instant situation from that which existed in
Our evaluation of this argument takes into account the rule that submitting a case fully stipulated does not lessen the need for petitioners to carry their burden of proof.
The evidence in support of petitioners' position is skimpy at best. Tax returns are not proof of the statements contained therein. [The taxpayer's] bookkeeping maneuvers merely shifted, on paper, the liability for prior loans. Hennessey's debit to * * * [the taxpayer's] drawing account, and its subsequent credit to that account and debit to * * * [the taxpayer's] undistributed taxable income account, do not reflect a current economic outlay entitling * * * [the taxpayer] to increase his basis in A & L. Although the entries in Hennessey's books technically reduced * * * [the taxpayer's] book equity, such entries could not, absent liquidation of Hennessey, leave * * * [the taxpayer] "poorer in a material sense." * * * [
1996 Tax Ct. Memo LEXIS 450">*461 Petitioners' reliance on In the ruling [
1996 Tax Ct. Memo LEXIS 450">*462 Petitioners contend that our approach to cases involving factual situations, such as is involved herein, unjustifiably singles out closely held S corporations for adverse tax treatment. We recognize that the decided cases seem to place a heavy burden on shareholders who seek to rearrange the indebtedness of related closely held S corporations. But close scrutiny of transactions between taxpayers and their controlled corporations has been the order of the day for a long period of time and applied in a myriad of tax cases too numerous to cite. Having noted the significance of the close relationship where S corporations are involved, we hasten to add that the existence of such a relationship is not necessarily fatal if other elements are present which clearly establish the bona fides of the transactions and their economic impact. See
Section 6661(a) provides for an addition to tax on underpayments attributable to a substantial understatement of income tax. Section 6661(b)(2)(A) defines the term "understatement" as the excess of the amount of tax required to be shown on the return for the taxable year over the amount shown on the return. An understatement is substantial if it exceeds the greater of 10 percent of the tax required to be shown on the return or $ 5,000. Sec. 6661(b)(1)(A). 1996 Tax Ct. Memo LEXIS 450">*464 Our denial of petitioner's passthrough loss from ABDC results in an understatement greater than $ 5,000.
The section 6661 addition to tax is not applicable, however, if there was substantial authority for petitioners' treatment of the items in issue or if the relevant facts relating to the tax treatment were adequately disclosed on the return. Sec. 6661(b)(2)(B)(i) and (ii).
"Substantial authority" requires that, when the facts and authorities are analyzed with respect to the petitioners' case, the weight of the authorities that support the petitioners' position should be substantial when compared with those supporting the contrary position. H. Conf. Rept. 97-760 at 575 (1982),
Petitioners argue that there was substantial authority for their position, in particular
Petitioners also argue that they adequately disclosed the relevant facts relating to the transactions on their return. Two types of disclosure are provided for: (1) Disclosure in statements attached to the return,
Taxpayers can meet the requirements of adequate disclosure by providing on the return sufficient information to enable respondent to identify the potential controversy involved.
1996 Tax Ct. Memo LEXIS 450">*467 In sum, we hold that petitioners' assertions in respect of basis under section 1366(d)(1)(B) and liability for the addition to tax under section 6661 should be rejected and respondent's determinations sustained.
To reflect the foregoing and to take into account other possible adjustments,
Footnotes
1. All section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩
2. Many of the cases involve tax years beginning prior to Dec. 31, 1982, to which sec. 1374(c)(2) applied. Sec. 1366(d)(1) replaced sec. 1374(c)(2) without significant change.↩
3. See also
;Wilson v. Commissioner , T.C. Memo. 1991-544 ;Griffith v. Commissioner , T.C. Memo. 1988-445 .Shebester v. Commissioner , T.C. Memo. 1987-246↩4. We took the same view in
, andWilson v. Commissioner , T.C. Memo 1991-544">T.C. Memo. 1991-544 .Burnstein v. Commissioner , T.C. Memo. 1984-74↩5. See also
. We note that, in any event, revenue rulings are not entitled to any special deference. E.g.,Gilday v. Commissioner , T.C. Memo. 1982-242 , 535 F.2d 309">312 n.2 (5th Cir. 1976), affg.Underwood v. Commissioner , 535 F.2d 309">535 F.2d 30963 T.C. 468">63 T.C. 468 (1975); , 100 T.C. 216">232 (1993), affd. without published opinionHalliburton Co. v. Commissioner , 100 T.C. 216">100 T.C. 21625 F.3d 1043">25 F.3d 1043↩ (5th Cir. 1994).6. We note that in
, the taxpayer-shareholders' funds had found their way to the S corporation to whom the taxpayer-shareholder became indebted, albeit we were unwilling to treat those funds as having been initially advanced on his behalf.Hitchins v. Commissioner , 103 T.C. 711↩ (1994)7. See also
, where we sustained respondent's determination under sec. 6661 on the basis of lack of disclosure and lack of substantial authority.Wilson v. Commissioner , T.C. Memo. 1991-544↩