1982 Tax Ct. Memo LEXIS 512 | Tax Ct. | 1982
MEMORANDUM FINDINGS OF FACT AND OPINION
FAY,
FINDINGS OF FACT
Some facts have been stipulated and are found accordingly.
Petitioners, Donald S. Gilday and Patsy L. Gilday, resided in Las Vegas, Nev., when they filed their petition herein.
During 1976, petitioners owned 25 percent of Foxy's Jackpot City, Inc. (Foxy's), a Nevada corporation. At that time, the other 25 percent shareholders were Melvin B. Wolzinger (Wolzinger), Earl E. Wilson (Wilson), and Michael Stober. 2 At all times relevant herein, Foxy's was an electing small business corporation within the meaning of section 1371(b). 1982 Tax Ct. Memo LEXIS 512">*514
On April 23, 1976, Foxy's borrowed $ 100,000 from the First National Bank of Nevada (FNB), and Foxy's shareholders guaranteed repayment of the loan. On August 9, 1976, Foxy's borrowed an additional $ 350,000 from FNB and, thus, increased its note to FNB to $ 450,000. Again, Foxy's shareholders guaranteed repayment.
On December 23, 1976, the shareholders gave FNB their personal note for $ 450,000, and FNB canceled Foxy's $ 450,000 note to FNB. FNB agreed because Wolzinger and Wilson had an excellent record in the casino business, and FNB had made the original loans to Foxy's based on their credit.
The parties agree the substitution of the shareholders' note to FNB for Foxy's note to FNB was motivated by tax considerations. The transaction was planned by Robert McKnight, an accountant who managed the tax practice for a certified public accounting firm. The planned result "definitely was loans from [the] stockholders" to Foxy's. On August 7, 1977, Foxy's gave its shareholders a note for $ 450,000. Although the note was not issued until1982 Tax Ct. Memo LEXIS 512">*515 1977, Foxy's financial statement for 1976 listed the $ 450,000 debt as a liability of Foxy's. 3
In 1976, Foxy's reported a $ 568,124 net operating loss. Petitioners' share of that loss was $ 142,031, and they deducted that amount on their 1976 Federal income tax return. 4 In his statutory notice of deficiency, respondent disallowed that deduction to the extent it exceeded $ 41,250--the sum of petitioners' original capital contributions to Foxy's plus some direct loans petitioners made to Foxy's which are not at issue herein.
OPINION
At issue is whether substitution of the shareholders' note to FNB for Foxy's note to FNB created a debt from Foxy's1982 Tax Ct. Memo LEXIS 512">*516 to the shareholders so as to increase the shareholders' bases in Foxy's within the meaning of section 1374(c)(2)(B).
Generally stated, section 1374(a) permits the shareholders of an electing small business corporation to deduct the corporation's net operating losses. However, a shareholder's portion of the corporation's net operating loss may not exceed the sum of (1) the shareholder's adjusted basis in his stock and (2) the shareholder's adjusted basis in any debt of the corporation owed to the shareholder. Sec. 1374(c)(2).
It is undisputed Foxy's suffered a net operating loss of $ 568,124 in 1976; petitioner's share of that loss was $ 142,031, irrespective of the section 1374(c)(2) limitations; and petitioners' adjusted basis in stock and debt totaled $ 41,250 without counting the transaction at issue herein. Respondent maintains the substitution of the shareholders' note to FNB for Foxy's note to FNB did not create a corporate debt to the shareholders within the meaning of section 1374(c)(2)(B). Thus, he contends the substitution does not increase petitioners' basis in Foxy's for purposes of deducting their share of Foxy's 1976 net operating loss. Petitioners maintain a1982 Tax Ct. Memo LEXIS 512">*517 valid corporate debt to the shareholders was created. 5 We agree with petitioners.
While petitioners were merely guarantors of Foxy's debt to FNB they acquired no basis in that debt. When a shareholder guarantees a corporation's debt, the shareholder has not increased his investment in the corporation simply because he may never have to make any actual payments. See
Both parties argue the effect of the change of positions is governed by
Petitioners maintain this case is indistinguishable from
To reflect the foregoing,
Footnotes
1. Unless otherwise provided, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the year in issue.↩
2. During 1977, Foxy's redeemed Michael Stober's shares thereby increasing petitioners' percentage ownership to 33-1/3 percent.↩
3. That liability is listed on the 1976 balance sheet under "notes payable to bank." However, a balance sheet footnote explains the substitution of the shareholders as primary obligors indicating Foxy's liability really ran from Foxy's to the shareholders. The accountant who prepared the financial statement acknowledged at trial that the statement "probably should have shown [the $ 450,000] as [a] note payable to stockholders," but he felt the footnote method was a more complete treatment.↩
4. See sec. 1374(c)(1).↩
5. If a valid corporate debt to the shareholders arose, it is clear petitioners' basis would increase sufficiently to absorb petitioners' entire share of Foxy's 1976 net operating loss.↩
6. Although revenue rulings are not binding on this Court, both parties argued
Rev. Rul. 75-144↩ is correct and determines the outcome of this case.7. In effect, respondent concedes petitioners are entitled to their claimed deduction if a debt from Foxy's to petitioners arose. ↩
8. During 1977, Foxy's made payments directly to the bank. However, to pay the shareholders and have the shareholders pay FNB would seem to be the utilization of fruitless steps.↩