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Uri v. C.I.R., 949 F.2d 371, 68 A.F.T.R.2d 91-5891, 91-2 USTC P 50,556

Facts

During the tax years in question, petitioners Cathaleen Uri and Stevens J. Townsdin were stockholders in The Old Opera House Mall Company, which they formed to renovate a building in downtown Concordia, Kansas. They each contributed $10,000 to capitalize the corporation, which elected to be taxed as a small business corporation under subchapter S. The corporation borrowed money from a local bank, secured by personal guarantees from the shareholders. After suffering financial losses, both shareholders filed for bankruptcy, and the corporation eventually filed for bankruptcy as well. They claimed enhanced loss deductions based on their personal guarantees, which the Commissioner disallowed.

During the tax years in question, petitioners Cathaleen Uri and Stevens J. Townsdin were stockholders in The Old Opera House Mall Company (referred to as “the corporation” in this opinion), formed by Mrs. Uri and Mr. Townsdin as the business vehicle for renovation of a building in downtown Concordia, Kansas.

Issue

Whether a shareholder in a subchapter S corporation who personally guarantees a bank loan to the corporation may increase his or her adjusted basis in the corporation's stock by the prorated amount of the guarantee to increase the available loss deduction under I.R.C. § 1374.

The issue in these consolidated appeals is whether a shareholder in a subchapter S corporation who personally guarantees a bank loan to the corporation may increase his or her adjusted basis in the corporation's stock by the prorated amount of the guarantee in order to increase the available loss deduction under the applicable version of I.R.C. § 1374.

Rule

I.R.C. § 1374 allows a pro-rata pass-through of net corporate losses to subchapter S corporate shareholders up to the amount of the taxpayer's adjusted basis in corporate stock plus the adjusted basis of the corporation's debt to the same taxpayer.

I.R.C. § 1374 allowed a pro-rata pass-through of net corporate losses to subchapter S corporate shareholders up to the amount of the taxpayer's adjusted basis in corporate stock plus the adjusted basis of the corporation's debt to the same taxpayer.

Analysis

The court applied the rule by examining whether the personal guarantees constituted an actual economic outlay that could be included in the shareholders' adjusted basis. The Tax Court had previously ruled that personal guarantees do not qualify as cash or property contributions, and the court affirmed this reasoning. The court emphasized that the shareholders did not make an actual economic transfer for the benefit of the corporation under the guarantees, thus disallowing the enhanced loss deductions.

The Tax Court denied the taxpayers' petitions, citing its opinion in Estate of Leavitt v. Comm'r, 90 T.C. 206 (1988), aff'd, 875 F.2d 420 (4th Cir.)… The Tax Court held that because petitioners' personal guarantees were neither cash nor other property, the guarantees could not be considered as part of petitioners' adjusted basis in the corporation's stock.

Conclusion

The court affirmed the decision of the United States Tax Court, upholding the disallowance of the enhanced loss deductions claimed by the shareholders.

Accordingly, the decisions of the United States Tax Court are AFFIRMED.

Who won?

The Commissioner of Internal Revenue prevailed in the case because the court upheld the disallowance of the enhanced loss deductions, ruling that the personal guarantees did not constitute an increase in the shareholders' adjusted basis.

The Commissioner disallowed these pass-through losses. In denying the amount personally guaranteed as part of petitioners' § 1374 allowance for subchapter S loss pass-through, the Commissioner noted that petitioners were never called upon to make an actual economic transfer for the benefit of the corporation under the guarantee.

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