Estate of Alton Bean v. CIR , 268 F.3d 553 ( 2001 )

United States Court of Appeals
FOR THE EIGHTH CIRCUIT
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No. 01-1501
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Estate of Alton Bean, Deceased; *
Gary A. Bean, Administrator; *
Mable Bean, *
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Appellants, *
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v. *
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Commissioner of Internal Revenue, *
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Appellee. * Appeal from the
_______________ * United States Tax Court.
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Gary A. Bean; Cynthia Bean, *
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Appellants, *
*
v. *
*
Commissioner of Internal Revenue, *
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Appellee. *
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Submitted: September 10, 2001
Filed: October 1, 2001
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Before McMILLIAN, BEAM, and HANSEN, Circuit Judges.
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HANSEN, Circuit Judge.
The shareholders of an S corporation appeal the United States Tax Court's1
decision upholding deficiencies assessed against them based on net operating losses
incurred by the S corporation and passed through to the individual shareholders.
Although not a shareholder of the S corporation, Cynthia Bean also appeals, as
deficiencies were assessed against her because she filed a joint tax return with her
husband, Gary Bean, one of the shareholders. The Internal Revenue Service
(hereinafter "IRS") disallowed the losses claimed on the taxpayers'2 individual tax
returns to the extent the losses exceeded the shareholders' respective bases in the S
corporation. The tax court upheld the deficiencies, and we now affirm the tax court's
judgment.
I.
Alton Bean Trucking, Inc., a corporation electing treatment under subchapter S
of the Internal Revenue Code, experienced net operating losses of $1,190,460 and
$482,481 for the tax years of 1990 and 1991, respectively. The shareholders of Alton
Bean Trucking, Inc., Alton Bean (now deceased), Mable Bean, and Gary Bean
(collectively referred to herein as "shareholders"), claimed their pro rata share of those
losses on their individual tax returns for the years 1987 through 1992, by way of loss
carrybacks and carryforwards. The IRS disallowed the losses as exceeding the
shareholders' respective bases in the S corporation and assessed tax deficiencies against
Alton and Mable Bean and against Gary and Cynthia Bean. Gary (in his capacity as
1
The Honorable Stephen J. Swift, United States Tax Court.
2
References to "taxpayers" include each of the individuals against whom the
deficiencies were filed: Alton Bean, Mable Bean, Gary Bean, and Cynthia Bean.
2
the administrator of his father's estate) and Mable appealed the assessments issued
against Alton and Mable, and Gary and Cynthia appealed the assessments issued
against them to the tax court, which consolidated the two cases for trial and disposition.
The Beans argued that certain transactions increased their respective bases in the S
corporation, which would allow them to recognize more of the corporation's losses on
their own tax returns. The tax court rejected their arguments and upheld the
assessments.
II.
We review the tax court's fact findings for clear error and its legal conclusions
de novo. McNamara v. Comm’r, 236 F.3d 410, 412 (8th Cir. 2000). The taxpayers
bear the burden of proving that they are entitled to deductions for an S corporation’s
losses that are passed through to the shareholders. Parrish v. Comm’r, 168 F.3d 1098,
1101 (8th Cir. 1999).
An S corporation is referred to as a passthrough entity because the items of
income and expense are not taxed at the corporate level, but are passed through to each
shareholder in his or her pro rata share, which shareholder then reports the income and
expenses on his or her individual tax return. A shareholder is limited in the amount of
loss flowing from the S corporation that he or she may recognize on his or her
individual tax return in a given year to the sum of the adjusted basis of the shareholder's
stock and the adjusted basis of any indebtedness owed to the shareholder from the
corporation. I.R.C. § 1366(d)(1), 26 U.S.C. § 1366(d)(1) (1994). Any loss disallowed
by reason of section 1366(d)(1) is carried forward indefinitely until the shareholder has
sufficient basis in stock and indebtedness to recognize the loss. I.R.C. § 1366(d)(2).
In this case, the shareholders were denied net operating losses that they had reported
on their individual tax returns for losses that Alton Bean Trucking, Inc. experienced in
1990 and 1991 because the shareholders each had inadequate basis in stock and
indebtedness under section 1366(d)(1). The taxpayers argue that certain transactions
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should have increased the shareholders' bases and that they should have been allowed
to recognize at least a portion of the S corporation's losses from 1990 and 1991.
The first of the disputed transactions surrounds the transfer of assets to the S
corporation from a related entity operated by the Beans. Alton and Gary Bean operated
a trucking company in Amity, Arkansas. Alton owned 75% interest in of the business
and Gary owned the remaining 25% interest. Although Alton and Gary reported their
respective shares of the income and expenses of the business on Schedule C (for sole
proprietors) filed with their individual tax returns, they treated the business as a
partnership under the name of Alton Bean Trucking Company (hereinafter "Company").
In 1988, the Beans formed an S corporation named Alton Bean Trucking, Inc.
(hereinafter "Inc."). Alton owned 50% of the corporate stock, his wife Mable owned
25%, and Gary owned 25%. They continued to run both companies through 1992.
Pursuant to a written agreement dated December 31, 1992, Company sold all of its
assets, except a receivable due from Inc. to Inc., and Inc. assumed all of Company's
liabilities. No cash exchanged hands. For tax purposes, Company treated the liabilities
assumed by Inc. as equal to Company's tax basis in the assets transferred so that neither
Company nor Alton and Gary reported any income or loss on the sale.
The taxpayers now argue that there was equity in the assets transferred from
Company to Inc., which assets were allegedly owned by Alton and Gary individually,
and that the equity should be recognized as capital contributions by Alton and Gary to
Inc., which would in turn increase their respective bases in Inc. We reject this
argument for two reasons. First, the transfer of assets was from Company to Inc. rather
than from the individual partners to Inc. Thus, to the extent that there was any equity
in the assets, the equity was that of the partnership, not the individual partners. The
partnership was an entity distinct from its partners, and the partners cannot bootstrap
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their bases in the corporation by transfers made by the partnership.3 See Bergman v.
United States, 174 F.3d 928, 932 (8th Cir. 1999) ("No basis is created for a shareholder
. . . when funds are advanced to an S corporation by a separate entity, even one closely
related to the shareholder."); Frankel v. Comm’r, 61 T.C. 343, 348 (1973) (holding that
a loan from a partnership to an S corporation did not increase the shareholders' bases,
even though the partners of the partnership were also the shareholders of the S
corporation), aff'd, 506 F.2d 1051 (3d Cir. 1974) (unpublished). The fact that the
partnership was dissolved following the sale in 1992 does not change the form of the
transaction that the taxpayers chose to utilize–selling the assets from the partnership to
the corporation. Once chosen, the taxpayers are bound by the consequences of the
transaction as structured, even if hindsight reveals a more favorable tax treatment.
Grojean v. Comm’r, 248 F.3d 572, 576 (7th Cir. 2001).
We also reject the taxpayers' argument because they have failed to meet their
burden of establishing that there was in fact equity in the assets. See Parrish, 168 F.3d
at 1102 (holding that taxpayer bears burden of establishing his basis in S corporation).
The partners avoided tax on the sale of the assets by treating the assets as equal in
value to the liabilities assumed by Inc. Irrespective of who owned the assets, the
taxpayers have provided no evidence that the assets were worth more than the liabilities
assumed by Inc. to support their assertion that there was equity in the assets transferred
to Inc. Thus, the shareholders are not entitled to increased bases for any alleged equity
in assets sold by Company to Inc.
Between 1988 and 1992, Company provided services and parts to Inc. and
leased trucks to Inc. Following the sale of Company's assets to Inc., Company's only
3
Although the taxpayers suggest that Company was not really an entity separate
from Alton and Gary as individuals, Company's accountant prepared financial
statements for Company as a whole, and the taxpayers stipulated before the tax court
that Company was a partnership. Further, the purchase agreement stated that Company
was selling the assets, not the individual partners.
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asset listed on its December 31, 1992, financial statement was a receivable from
Affiliate (Inc.) in the amount of $284,618. Alton and Gary argue that they are entitled
to increases in their bases for the amount of the receivable because they were never
paid for the services and lease payments, which made up the receivable. This argument
fails for the same reason as the first argument. Any transactions that purportedly made
up the balance of the receivable were between Company and Inc. Thus, the balance in
the receivable could not increase the individual shareholders' bases. Bergman, 174
F.3d at 932; see also Hitchins v. Comm’r, 103 T.C. 711, 715 (1994) ("[T]he
indebtedness of the S corporation must run directly to the shareholders: an indebtedness
to an entity with passthrough characteristics which advanced the funds and is closely
related to the taxpayer does not satisfy the statutory requirements [of § 1366(d)].").
The taxpayers cannot establish that the shareholders are entitled to an increase
in basis unless the receivable was distributed by the partnership to the individual
partners and then contributed to Inc. or otherwise assumed by the individual partners.
The taxpayers have offered no such evidence. As such, we cannot say that the tax
court clearly erred in finding that the receivable was owed to the partnership rather than
to the individual partners. The only documentary evidence actually favors the opposite
conclusion, that is, that the taxpayers continued to treat the receivable as one owed by
Inc. to Company, not to the individual partners. Inc.'s December 31, 1992, financial
statement following the sale of the Company assets reflects the amount owed to
Company as a liability "Due to Affiliate," although Inc. also reported amounts in an
account titled "Due to Officers." If the taxpayers had intended the receivable to run
from Inc. to the individuals, we would expect to see the amount included in the "Due
to Officers" account rather than the "Due to Affiliate" account. The shareholders have
failed to establish that they contributed anything to Inc. related to the amounts allegedly
owed from Inc. to Company but never paid.4
4
The tax court also found that the taxpayers failed to substantiate the amount
allegedly owed from Inc. to Company for parts, service, and lease payments. We
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The final transaction that the taxpayers argue should increase the shareholders'
bases in Inc. relates to loans that Inc. received from the Bank of Amity that were
secured by real estate owned by the taxpayers. The Bank of Amity extended a
$600,000 line of credit to Inc. in 1992 and took personal guarantees from Alton and
Gary, as well as a mortgage from Alton and Mable and from Gary and Cynthia for real
estate owned by them personally. Alton and Mable also gave the bank a second
mortgage in 1990 in the amount of $960,019 to secure Inc.’s indebtedness to the bank.
The taxpayers acknowledge that the loans were made directly from the Bank of Amity
to Inc. but argue that by giving mortgages on their personally owned real estate, the
shareholders have suffered an "economic outlay" sufficient to create basis in Inc.
To be entitled to an increase in basis, the shareholders must show that the
mortgages on their personal real estate either increased their stock basis, i.e., the
shareholders contributed the real property to the S corporation, or created a debt from
the S corporation to the shareholders. See I.R.C. § 1366(d)(1). The economic outlay
doctrine is one way of showing that a loan involving a third party is actually a loan from
the shareholder to the corporation. However, for the doctrine to apply, the shareholder
"must make an actual economic outlay to increase his basis in an S corporation."
Bergman, 174 F.3d at 932. The transaction, when fully consummated, must leave "the
taxpayer poorer in a material sense" before a transaction increases a shareholder's
basis. Id. (internal quotations omitted) (remanding based on fact issue of whether loan
to corporation, which was then restructured as loan to shareholder who then made loan
to corporation, resulted in an economic outlay by the shareholder).
likewise cannot say that the tax court clearly erred in making this finding, as the only
evidence offered is testimony by Cynthia Bean, who worked for Inc., that "by logic, it
[the receivable account] would probably– I don't know exactly but I would assume that
it is–it would probably entail the rental, possibly the parts." (J.A. at 648.)
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The taxpayers concede that a mere guaranty of a corporate loan is insufficient
to give them basis for the amount of the loan, and we agree. See Harris v. United
States, 902 F.2d 439, 445 (5th Cir. 1990); Leavitt v. Comm’r, 875 F.2d 420, 422 (4th
Cir.) cert. denied, 493 U.S. 958 (1989). They argue, however, that by giving a
mortgage on their real estate to secure Inc.'s loan, they have suffered an actual
economic outlay. The Fifth Circuit has rejected such an argument. See Harris, 902
F.2d at 445 & n.16 (holding that there was no economic outlay although shareholder
pledged personally owned certificates of deposit); see also Calcutt v. Comm’r, 84 T.C.
716, 719-20 (1985) (rejecting argument based on at-risk rules of I.R.C. § 465 and
holding that mortgage on personal residence to secure bank loan to S corporation did
not increase shareholder's basis in S corporation). But see Selfe v. United States, 778
F.2d 769, 772-73 n.7 (11th Cir. 1985) (noting that "a guarantor who has pledged stock
to secure a loan has experienced an economic outlay to the extent that that pledged
stock is not available as collateral for other investments").
We agree with the Fifth Circuit that a shareholder's pledge of personally owned
property, without more, is not an economic outlay and is insufficient to create basis in
the S corporation. The purpose of the economic outlay doctrine is to determine
whether the corporation is indebted to the shareholder, thus creating basis for the
shareholder under section 1366(d)(1)(B) of the Internal Revenue Code. A personal
guaranty creates basis only when the shareholder's duty under the guaranty is triggered;
that is, when he is actually called upon to make good on the guaranty. See Harris, 902
F.2d at 445 ("[T]he wholly unperformed guarantees do not satisfy the requirement that
an economic outlay be made . . .."); Leavitt, 875 F.2d at 422 ("[T]he appellants have
experienced no such call as guarantors, have engaged in no economic outlay, and have
suffered no cost."); Brown v. Comm’r, 706 F.2d 755, 757 (6th Cir. 1983) (holding that
a guaranty was not an economic outlay until the shareholder personally satisfied at least
a portion of the guaranteed debt). At that point, the corporation is indebted to the
shareholder because the shareholder has actually paid the corporation's debt. This is
consistent with section 1012 of the Internal Revenue Code, which states that the "basis
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of property shall be the cost of such property," and the related tax regulations, which
define a property's cost as the amount paid in cash or with other property. I.R.C. Reg.
§ 1.1012-1(a). See also Leavitt, 875 F.2d at 422 n.9 (relying on § 1012 and its
regulations to hold that a personal guaranty does not create basis).
We believe that a mortgage or pledge of property is similar to a guaranty. A
corporation is not indebted to the shareholder simply because the shareholder has
mortgaged his property but becomes indebted only when the mortgage is called to
satisfy the corporation's debt. At that time, the corporation is indebted to the
shareholder because the shareholder has "paid" the corporation's debt "in other
property." I.R.C. Reg. § 1.1012-1(a). Until the mortgage is called to satisfy the
corporation's debt, however, we hold that the shareholder has not suffered an economic
outlay and is not entitled to an increase in basis.
Finally, the taxpayers argue that they should be allowed to use the IRS's net
worth calculations developed during the audit to increase the shareholders' bases in Inc.
A net worth calculation is an indirect method of determining whether an entity has
reported all of its income. If Inc. had additional income that it had not reported, then
the shareholders' bases in Inc. would likewise increase. See I.R.C. § 1367(a)(1)
(shareholder's basis is increased by his pro rata share of the S corporation's net
income). During the audit, the IRS issued various "Income Tax Examination Changes"
to the Beans. One such proposed change was based on the net worth calculations
performed during the audit. The final changes that supported the assessed deficiencies
were based on the actual tax returns filed by Inc. and were higher than the suggested
changes based on the net worth calculations. The taxpayers argue that the net worth
calculations should be afforded the same presumption of correctness when offered by
the taxpayer as they are given when offered by the IRS and that the net worth
calculations support an increase in the shareholders' bases.
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The IRS agent who prepared the net worth calculations testified that the
calculations were not reliable because he had not performed certain audit procedures
necessary for a complete and accurate calculation. He also testified that he ultimately
did not rely on the net worth calculations because he determined that Inc.'s income was
accurate as reported. We reject the taxpayers' attempt to utilize the incomplete
calculations merely because they are advantageous without further substantiating the
calculations. The only evidence in the record is that the calculations are incomplete.
The taxpayers cannot rely on the incomplete calculations to meet their burden of
establishing the shareholders' bases, Parrish, 168 F.3d at 1102, without demonstrating
the calculations' accurateness.
III.
For the foregoing reasons, we affirm the tax court's judgment.
A true copy.
Attest:
CLERK, U.S. COURT OF APPEALS, EIGHTH CIRCUIT.
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