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The following alert is from Desmond Sheridan.
U.S. Court of Appeals Rules on Shareholder Loans to S corporations
The U.S. Court of Appeals affirmed a Tax Court ruling that S corporation shareholders did not make an "economic outlay" on loans to their S corporation, so they did not acquire basis in the debt to deduct the S corporation's losses.
Background. Deductions and losses of an S corporation are passed through to shareholders and claimed on their own returns. However, a shareholder may deduct his share of these passed-through items only to the extent of his adjusted basis in the S corporation stock plus any debt owed to the shareholder by the corporation. Unused deduction or loss may be carried over and used in the future to the extent the shareholder then has basis.
Facts. In 1997, Donald Russell and Loren Kopseng owned an S corporation, Missouri River Royalty Corporation (MMRC).
MRRC owed money to a bank as well as other entities controlled by Russell and Kopseng. MRRC reported a substantial loss in 1997 which exceeded Russell's and Kopseng's bases in their MRRC stock. Russell and Kopseng maintained that their respective bases in all of MRRC's debt (even though not owed to them directly) allowed them to deduct additional MRRC losses.
Tax Court decision. The Tax Court held that, with the exception of actual cash advances, Russell and Kopseng couldn't increase their bases in MRRC by the amount of MRRC's debt. That was because this debt did not constitute "indebtedness of the S corporation to the shareholders" because there was no actual economic outlay by the shareholders. This was the case even though entities owned by the shareholders did make an outlay. Court of Appeals decision. The Eighth Circuit affirmed the Tax Court decision, finding no error in the ruling. Accordingly, the several loans did not constitute "indebtedness of the S corporation to the shareholder," and, therefore, Russell and Kopseng could not claim losses incurred by MMRC. This ruling is really nothing new but is a reminder that S corporation loans must be carefully considered to ensure they will create basis for loss deduction. One nice thing about LLCs (which are generally taxed as partnerships): this is not an issue. |
About the Writer
Desmond G. Sheridan is a partner in the Greensboro law firm of Isaacson Isaacson Sheridan & Fountain, LLP and is a certified public accountant. His practice areas are business transactions, tax, corporations, limited liability companies, commercial real estate and estate planning. Sheridan has served on the Board of Directors of the North Carolina Association of Certified Public Accountants and has been recognized as a "Best Lawyer in America," a North Carolina "Super Lawyer" and a member of the "Legal Elite" by Business North Carolina. He has given numerous continuing education presentations to CPAs and attorneys. |
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