Estate of Leavitt v. Comm
Facts:
As shareholders of VAFLA Corporation, an S corporation, the appellants claimed deductions to reflect the corporation’s operating losses. The commissioner disallowed deductions above the $10,000 bases from original investment. The appellants contend that the adjusted basis in their stock should be increased to reflect a $300,000 loan. The loan was obtained by VAFLA from bank and was guaranteed by the shareholder-guarantors. VAFLA made all of the loan payments, principals and interest to the bank and the appellants did not. Neither VAFLA nor the shareholder-guarantors treated the loan as constructive income taxable to the shareholder-guarantors.
Because the bank lent the loan to the shareholder-guarantors and then they contributed the funds to the corporation, the appellants present that the loan is a capital contribution from appellants to VAFLA. If it is characterized as equity, they should be entitled to add a pro rata share of the loan to their adjusted basis. The Tax Court disallowed such increase in basis.
Issues:
The issue is whether the shareholder-guarantors should add a pro rata share of the loan to their adjusted basis and deduct operating losses to the extent of the basis.
Court holdings:
U.S Court of Appeals affirmed the Tax Court decision, concluding that shareholders’ basis in stock wasn’t increased by personal guarantees given as collateral and proportionate shares of NOL was limited to initial investment.
Analysis and Discussion:
To increase the basis in the stock of an S corporation, there must be an economic outlay on the part of the shareholder. A guarantee itself cannot fulfill that requirement. VAFLA made all the payments to the bank and the appellants have not experienced no cost and thus no economic outlay. If VAFLA had defaulted and the shareholder-guarantors made actual disbursements on the