T.C. Memo. 2000-355
UNITED STATES TAX COURT
ESTATE OF ALTON BEAN, DECEASED, GARY A. BEAN, ADMINISTRATOR, AND
MABLE BEAN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
GARY A. BEAN AND CYNTHIA BEAN, Petitioners v. COMMISSIONER OF
INTERNAL REVENUE, Respondent
Docket Nos. 5228-99, 5229-99. Filed November 15, 2000.
James Allen Brown, for petitioners.
Brian A. Smith, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
SWIFT, Judge: These cases were consolidated for trial,
briefing, and opinion. For years 1987 through 1992, respondent
determined deficiencies in petitioners' Federal income taxes and
accuracy-related penalties as follows:
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Alton and Mable Bean
Accuracy-Related Penalty
Year Deficiency Sec. 6662(a)
1987 $101,941 ---
1988 14,143 ---
1989 26,741 ---
1990 51,787 $10,357
1991 54,005 10,801
1992 39,656 7,931
Gary and Cynthia Bean
Accuracy-Related Penalty
Year Deficiency Sec. 6662(a)
1987 $ 3,041 ---
1988 3,056 ---
1989 8,891 ---
1990 24,575 $4,915
1991 31,999 6,400
1992 19,378 3,876
The issues for decision involve whether petitioners are
entitled to increased bases in their investments in an
S corporation as a result of (1) petitioners' personal guaranties
of the corporation's indebtedness on bank loans, (2) a transfer
of partnership assets to the S corporation, and (3) corporate
liabilities owed to a partnership. Also at issue is whether
petitioners are liable for the accuracy-related penalties.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
Alton Bean, decedent, died in January of 1999 in Amity,
Arkansas. Decedent and petitioner Mable Bean were husband and
wife and the parents of petitioner Gary Bean. Petitioners Gary
and Cynthia Bean are husband and wife. At the time the petitions
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were filed, Mable, Gary, and Cynthia Bean resided in Amity,
Arkansas.
Shortly after decedent’s death, Gary Bean was appointed
administrator of decedent’s estate.
For convenience, hereinafter all references to petitioners
refer to decedent and Mable Bean and to Gary and Cynthia Bean.
For many years, decedent and Gary Bean jointly owned and
managed a trucking business in Amity, Arkansas. Through 1992,
decedent and Gary Bean operated the trucking business as a
partnership (the Partnership). During all relevant periods,
decedent owned a 75-percent interest in the Partnership, and Gary
Bean owned a 25-percent interest in the Partnership.
On April 30, 1988, decedent, Mable, and Gary Bean formed an
Arkansas corporation (the Corporation) that elected in 1989 to be
taxed pursuant to subchapter S of the Internal Revenue Code.
From early 1988 through 1992, decedent and Mable Bean owned 75
percent of the stock in the Corporation, and Gary Bean owned the
remaining 25 percent of the stock in the Corporation.
Through 1992, the Corporation, through its employees,
provided maintenance on and parts for the trucks of the
Partnership.
On October 9, 1990, decedent and Mable Bean executed a
$960,019 second mortgage on their personal residence to the Bank
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of Amity in order to secure certain indebtedness that the
Corporation owed to the Bank of Amity.
On December 30, 1992, to provide operating capital for the
Corporation, the Bank of Amity extended to the Corporation a
$600,000 line of credit. To secure repayment of funds actually
provided to the Corporation under the line of credit, the Bank of
Amity required each petitioner to sign personal guaranties for
repayment of such funds and to mortgage in favor of the Bank of
Amity certain additional real property they owned with a fair
market value, on December 23, 1993, of $570,500.
In the subsequent years through the date of trial, all
payments to the Bank of Amity that were made on the above
indebtedness were made by the Corporation. The Bank of Amity has
not foreclosed on the loans made to the Corporation.
On or shortly before December 31, 1992, the Partnership
transferred all but one of its assets to the Corporation, the
Corporation assumed all liabilities of the Partnership, and the
Corporation took over ownership and operation of the
Partnership's trucking business. The Corporation transferred no
cash to the Partnership. For income tax purposes, petitioners
treated this transaction as a sale of assets by the Partnership
to the Corporation for no gain to the Partnership (i.e., the
Partnership treated the amount of the liabilities assumed by the
Corporation as equal to the Partnership's tax basis in the assets
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transferred). As of December 31, 1992, the partners of the
Partnership had not dissolved the Partnership.
For 1990 and 1991, the Corporation realized operating losses
of $1,190,460 and $482,481, respectively.
On their joint Federal income tax returns for 1987 through
1992, prepared by petitioners' accountant, petitioners deducted
(through net operating loss carrybacks and carryovers) their
entire respective shares of the previously mentioned losses of
the Corporation for 1990 and 1991.
On audit, respondent determined that petitioners lacked
sufficient tax bases in their investments in the Corporation to
be entitled to any of the above-claimed loss deductions.
OPINION
Under section 1366, shareholders in an S corporation may
deduct their pro rata shares of the corporation's losses to the
extent the losses are supported by the shareholders' adjusted
bases in the stock and in any indebtedness of the S corporation
to the shareholders.
Unless the shareholders of the S corporation incur an
economic outlay with respect to indebtedness that the corporation
owes to third parties, the shareholders are not entitled to
increase their bases in their stock by the amount of the
indebtedness. See, e.g., Bergman v. United States, 174 F.3d 928,
932-934 (8th Cir. 1999); Estate of Leavitt v. Commissioner, 875
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F.2d 420, 422 (4th Cir. 1989), affg. 90 T.C. 206 (1988).
Accordingly, mere shareholder guaranties of corporate
indebtedness to third parties generally do not qualify as an
economic outlay, and they do not qualify as indebtedness from the
S corporations to the shareholders “until and unless the
shareholders pay part or all of the * * * [corporate
indebtedness].” Raynor v. Commissioner, 50 T.C. 762, 771 (1968);
see also Bergman v. United States, supra; Perry v. Commissioner,
47 T.C. 159, 162-163 (1966), affd. 392 F.2d 458 (8th Cir. 1968).
Likewise, where corporate indebtedness to third parties is merely
secured by the shareholders' property, no economic outlay has
occurred, no indebtedness to the shareholders exists, and
shareholders are not entitled to increase their bases in the
S corporation by the amount of the corporate indebtedness secured
by the shareholders. See Calcutt v. Commissioner, 84 T.C. 716,
720 (1985); Erwin v. Commissioner, T.C. Memo. 1989-80.
While taxpayers are free to organize their affairs as they
choose, once having done so, taxpayers generally are held to the
tax consequences of their choice and may not enjoy the benefit of
some other route that they might have chosen to follow but did
not. See Commissioner v. National Alfalfa Dehydrating & Milling
Co., 417 U.S. 134, 149 (1974), cited in Selfe v. United States,
778 F.2d 769, 773 (11th Cir. 1985).
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Petitioners herein contend that they are entitled to
increase their tax bases in the Corporation's indebtedness to the
Bank of Amity, to the extent they personally guaranteed and
secured such indebtedness. Petitioners rely heavily on Selfe v.
United States, supra. In that case, a bank made a loan to a
taxpayer individually, and the taxpayer secured the loan by a
pledge to the bank of shares of stock in a corporation. When the
taxpayer later incorporated a business, the above loan was
converted into a loan to the new corporation, accompanied by the
taxpayer's guaranty of the corporation's repayment of the loan to
the bank.
The Court of Appeals for the Eleventh Circuit held that,
although shareholder guaranties of subchapter S corporate
indebtedness generally will not increase the shareholder’s tax
basis in the corporation, a narrow exception may exist “where the
facts demonstrate that, in substance, the shareholder has
borrowed funds and subsequently advanced them to * * * [the]
corporation.” Id. Because material facts remained in dispute,
in Selfe, the Court of Appeals remanded the case to the trial
court to evaluate whether the loan from the bank should be
treated in reality as a loan to the taxpayer and then to the
S corporation.
By contrast, in the instant cases, the Bank of Amity
extended funds directly to the Corporation, and the Corporation
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has made all payments on the indebtedness to the bank.
Petitioners could have structured the indebtedness as
indebtedness to themselves, but petitioners chose to avoid
primary liability thereon.
Petitioners' secondary liability, as guarantors, may have
been necessary for bank approval of the indebtedness, but until
or unless petitioners are called upon to pay on the indebtedness,
petitioners' secondary liability is not enough, for tax purposes,
to treat the indebtedness as if made to petitioners. Petitioners
have not established that they incurred an economic outlay with
regard to the Corporation's indebtedness to the Bank of Amity,
and petitioners are not entitled to increase their tax bases in
their investments in the Corporation with respect thereto.
Because assets of the Partnership were transferred to the
Corporation, petitioners also contend that they are entitled to
increase their tax bases in the Corporation (1) by the amount
that the value of the assets the Partnership transferred to the
Corporation exceeds the amount of the Partnership’s liabilities
assumed by the Corporation, (2) by the amount of any Partnership
“equity” transferred to the Corporation, and (3) by the amount of
certain additional amounts allegedly owed to the Partnership.
In order to avoid recognition of partnership capital gain on
the transfer of assets to the Corporation, the partners of the
Partnership structured the transfer as a sale of assets to the
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Corporation for the assumption of the Partnership’s liabilities,
the amount of which was treated as equaling the Partnership's tax
basis in the assets. The transaction was not structured as a
taxable distribution of partnership assets to the partners
followed by a contribution of the assets to the Corporation with
a stepped-up tax bases. Petitioners have given us no sufficient
justification for recasting the transaction.
Even if the value of the Partnership assets that were
transferred to the Corporation exceeded the liabilities of the
Partnership that were assumed by the Corporation, even if
Partnership “equity” was transferred to the Corporation, and even
if the Corporation owed additional amounts to the Partnership,
such excess value, equity, or amounts would not increase the tax
bases of the shareholders in the Corporation. As explained in
Frankel v. Commissioner, 61 T.C. 343, 348 (1973) (involving the
predecessor to section 1366)--
The existence of the partnership cannot be ignored
here even though the partners were simultaneously
shareholders in the subchapter S corporation. If the
partners had directly * * * [transferred funds] to the
subchapter S corporation or treated it as an addition
to capital, the result would be different.
The distinctions that exist between partnerships,
sole proprietorships, and corporations do so from a tax
viewpoint by design. To treat the partnership * * *
[transfer] as having been made directly by the partners
would be to deliberately obfuscate the distinction
where no such action is called for. [Citations
omitted.]
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In the instant cases, the Partnership, not the shareholders of
the S corporation, made the transfer to the Corporation, and only
the Partnership would receive tax bases associated with the
transfer.
Despite the similar ownership interests of the partners of
the Partnership and of the shareholders of the Corporation,
petitioners, as shareholders in the Corporation, may not increase
their tax bases in their investments in the Corporation for any
purported value of Partnership assets (in excess of the
Partnership’s liabilities assumed), for any purported
Partnership's equity transferred to the Corporation, or for any
amounts owed to the Partnership.
Further, no credible evidence substantiates the existence of
the additional amounts allegedly owed to the Partnership. We
sustain respondent's deficiency determinations for each year in
issue.
Lastly, petitioners contend that the Corporation
underreported income for the years in issue and that the
additional unreported income should increase petitioners' tax
bases in the Corporation. Petitioners, however, for the years in
issue have provided no credible evidence that the Corporation's
income was underreported.
Under section 6662(a), taxpayers are subject to accuracy-
related penalties on underpayments with respect to which they
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were negligent. Negligence, in the present context, reflects
taxpayers' failure to make reasonable attempts to comply with the
Internal Revenue Code. See sec. 6662(c).
Accuracy-related penalties may be avoided if taxpayers show
that the errors were caused, in some significant part, by
detrimental reliance on the advice of qualified tax professionals
and that their reliance was reasonable and in good faith. See
sec. 6664(c); United States v. Boyle, 469 U.S. 241, 250 (1985);
Stanford v. Commissioner, 152 F.3d 450, 460-461 (5th Cir. 1998),
affg. in part and vacating on this issue 108 T.C. 344 (1997).
Petitioners employed an accountant to prepare their tax
returns for the years in issue. Having considered petitioners'
and the accountant's testimony, we conclude that petitioners
reasonably relied on the accountant to ascertain their tax bases
in the indebtedness of the Corporation. We do not sustain
respondent's imposition of the accuracy-related penalties.
To reflect the foregoing,
Decisions will be entered for
respondent as to the deficiency
amounts and for petitioners as to
the accuracy-related penalties.