                         T.C. Memo. 2005-75



                       UNITED STATES TAX COURT



                WILLIAM H. MALOOF, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 15211-02, 17951-03.    Filed April 6, 2005.



     Donald J. O’Connor, for petitioner.

     Anita A. Gill, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     KROUPA, Judge:    Respondent determined deficiencies in

petitioner’s Federal income tax by disallowing operating losses

sustained by an S corporation in which petitioner was the sole

shareholder.   After concessions, the sole issue before the Court

is whether petitioner is entitled to increase his adjusted basis

in the S corporation by $4 million, the amount of a loan a third
                                 - 2 -

party made to the S corporation.    Resolving this issue depends on

whether petitioner made an economic outlay regarding this loan to

allow petitioner to increase his basis in the S corporation.      We

hold that he did not.

                           FINDINGS OF FACT

     The parties have stipulated some facts.     The stipulation of

facts and the accompanying exhibits are incorporated by this

reference and are so found.

     Petitioner is the sole shareholder of several S corporations

involved in the propane gas industry.    One S corporation, Level

Propane, Petroleum & Gases Co., an Ohio corporation (Level

Propane),1 generated the losses petitioner claimed as passthrough

deductions in this case.    Level Propane provided propane gas to

rural areas in Ohio initially, then expanded into neighboring

States.   At its peak, Level Propane provided propane gas and

services to customers in 14 States and had about 600 employees

who generated approximately $18 million in annual revenues.

     Level Propane required increasingly large infusions of

capital to sustain its growth.    Level Propane’s capital needs

were funded initially with transfers from various S corporations

in which petitioner owned all the shares.     Eventually Level

Propane obtained financing from commercial lenders.     The specific


     1
      Neptune Propane, Inc., merged into Level Propane during
1993. Throughout this opinion references to Level Propane will
include Neptune to the extent relevant.
                                - 3 -

loan involved here is a $4 million loan2 from Provident Bank (the

bank) pursuant to a loan agreement dated July 29, 1993.

     The $4 million loan consisted of three principal components,

each collateralized differently.   First, there was a $750,000

equipment note that was secured by equipment Level Propane would

purchase with the loan proceeds.   Second, there was a $2.5

million revolving term loan that was secured by petroleum tanks

and supply contracts Level Propane owned.   Third, there was a

$750,000 demand loan that was secured by the inventory and

accounts receivable of Level Propane.   As additional collateral

for the $4 million loan to Level Propane, petitioner pledged all

the shares he owned of Level Propane and a $1 million life

insurance policy on his life.

     Level Propane made monthly interest payments on the $4

million loan through an account that Level Propane was required

to maintain with the bank.   Petitioner made no payments on the

loan.

     Level Propane defaulted on the loan and was forced into

involuntary bankruptcy.   At no time did the bank demand payment

from petitioner individually or begin collection action against

petitioner regarding the $4 million loan to Level Propane.



     2
      During his testimony, petitioner briefly referred to
approximately $60 million in loans. Petitioner failed to
introduce any evidence, however, to document any loans other than
the $4 million loan from Provident Bank.
                                    - 4 -

     Level Propane generated substantial losses3 during the years

at issue.        Petitioner increased his basis in the stock of Level

Propane by the amount of the $4 million loan to claim as

passthrough deductions the net operating losses of Level Propane.

Respondent determined that petitioner’s basis in the stock of

Level Propane did not increase by the amount of the $4 million

loan to Level Propane because petitioner had never paid nor had

he ever been called upon to pay any amount under the $4 million

loan.        Respondent consequently found that petitioner had

insufficient basis against which to deduct any losses.

Respondent mailed to petitioner notices of deficiency on June 28,

2002, and July 16, 2003, determining the following deficiencies:

                          Year              Deficiency
                                             1
                          1990                $169,270
                          1991                  77,709
                          1992                  47,733
                          1993                 351,162
                          1995                 305,162
                          1996               1,939,205
                          1998                  31,397
                          1999                  50,870
                          2000                 197,365
         1
         All dollar amounts are rounded to the nearest dollar.

     Petitioner timely filed a petition contesting respondent’s

determination, arguing that his basis was increased by the amount



     3
      Level Propane and Neptune Propane reported losses of
$2,341,173 in 1993. Most of petitioner’s increased basis,
consequently, would have been depleted in 1993. The deficiencies
respondent determined for 1995, 1996, 1998, 1999, and 2000,
therefore, would be sustained even if petitioner was allowed the
$4 million basis increase.
                               - 5 -

of the $4 million loan.   We must therefore determine whether

petitioner may increase his basis in the S corporation by the

amount of the $4 million loan so petitioner may deduct

passthrough operating losses of the S corporation.

                              OPINION

     Petitioner and respondent differ on the effect of the $4

million loan the bank made to Level Propane.   Petitioner argues

that he is entitled to increase his basis in the stock of Level

Propane by the amount of the loan for three reasons.    First,

petitioner argues that he is entitled to an increase in basis in

Level Propane because he personally guaranteed the loan.     Second,

petitioner argues that he is entitled to increase his basis in

Level Propane because he pledged stock to secure the loan.

Regarding this second argument, petitioner implies that Eleventh

Circuit precedent compels a different result from our own

caselaw.   Third, petitioner argues that he is entitled to

increase his basis in Level Propane because he incurred a cost

when he lost “control” of Level Propane.

     Respondent counters that neither petitioner’s guaranty, the

pledged stock, nor the bank’s “control” over Level Propane

constituted an economic outlay.   Respondent also argues that

Eleventh Circuit caselaw does not compel a different result.

     We address the parties’ contentions in turn.    First, we

state the general rules governing when a shareholder of an S
                               - 6 -

corporation is entitled to deduct losses the S corporation

sustained.   Petitioner bears the burden of proof.4

     When an S corporation incurs losses, the shareholders of the

S corporation, unlike shareholders of a C corporation, can

directly deduct their share of the entity level losses in

accordance with the flowthrough rules of subchapter S.    Section

1366(a)5 provides for the pro rata flowthrough of subchapter S

corporation income, losses, and deductions to the shareholders.

Section 1366(d)(1), however, limits the aggregate amount of

flowthrough losses and deductions a shareholder may claim.

     The losses cannot exceed the sum of the shareholder’s

adjusted basis in his or her stock and the shareholder’s adjusted

basis of any indebtedness of the S corporation to the

shareholder.   Sec. 1366(d)(1)(A) and (B).   This restriction


     4
      The Commissioner’s determinations are presumed correct, and
the taxpayer bears the burden of proving otherwise. Rule 142(a);
Welch v. Helvering, 290 U.S. 111, 115 (1933). Moreover,
deductions are a matter of legislative grace, and the taxpayer
bears the burden of proving he or she is entitled to any
deduction claimed. INDOPCO, Inc. v. Commissioner, 503 U.S. 79,
84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440
(1934); Welch v. Helvering, supra. This includes the burden of
substantiation. Hradesky v. Commissioner, 65 T.C. 87, 90 (1975),
affd. per curiam 540 F.2d 821 (5th Cir. 1976). The burden of
proof may shift to the Commissioner in certain situations if the
taxpayer complies with substantiation requirements and cooperates
with reasonable requests of the Commissioner. Sec. 7491(a)(2).
Because petitioner failed to show he satisfied these
requirements, the burden of proof remains with petitioner.
     5
      All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
                               - 7 -

applies because the disallowed amount exceeds the shareholder’s

economic investment in the S corporation and, because of the

limited liability accorded to S corporation shareholders, the

amount does not have to be repaid.     The disallowed losses and

deductions may be carried forward indefinitely, however, and

claimed when and to the extent that the shareholder increases his

or her basis in the S corporation.6    See sec. 1366(d)(2).

Economic Outlay

     A taxpayer must make an economic outlay for a loan to create

basis.   A taxpayer makes an economic outlay when he or she incurs

a “cost”7 on a third-party loan or is left poorer in a material

sense after the transaction.   Putnam v. Commissioner, 352 U.S. 82

(1956); Estate of Bean v. Commissioner, 268 F.3d 553, 558 (8th

Cir. 2001), affg. T.C. Memo. 2000-355; Bergman v. United States,

174 F.3d 928, 930 n.6 (8th Cir. 1999); Estate of Leavitt v.

Commissioner, 875 F.2d 420, 422 (4th Cir. 1989), affg. 90 T.C.

206 (1988); Brown v. Commissioner, 706 F.2d 755, 756 (6th Cir.

1983), affg. T.C. Memo. 1981-608; Spencer v. Commissioner, 110

T.C. 62, 83-84 (1998), affd. without published opinion 194 F.3d


     6
      Shareholders may increase basis in an S corporation by
capital contributions, stock purchases, or extensions of
additional credit, or where the S corporation generates taxable
income.
     7
      Basis of property is the “cost” of the property. Sec.
1012. “Cost” is defined as the “amount paid” for property “in
cash or other property.” Sec. 1.1012-1(a), Income Tax Regs.
                                 - 8 -

1324 (11th Cir. 1999); Underwood v. Commissioner, 63 T.C. 468,

477 (1975), affd. 535 F.2d 309 (5th Cir. 1976); Prashker v.

Commissioner, 59 T.C. 172 (1972); Perry v. Commissioner, 54 T.C.

1293, 1296 (1970), affd. 392 F.2d 458 (8th Cir. 1971); Raynor v.

Commissioner, 50 T.C. 762, 770-771 (1968); Horne v. Commissioner,

5 T.C. 250, 254 (1945).

     Against this background, we now address whether petitioner

may increase his basis in the S corporation by the amount of the

loan.    We address specifically petitioner’s contention that his

personal loan guaranty, the pledge of stock, and the bank’s

“control” of Level Propane, either singly or collectively,

constitute an economic outlay.

Personal Guaranty

        Shareholder guaranties of loans to an S corporation do not

constitute an economic outlay.     Estate of Leavitt v.

Commissioner, supra; Brown v. Commissioner, supra; Spencer v.

Commissioner, supra; Calcutt v. Commissioner, 84 T.C. 716, 719-

720 (1985); Perry v. Commissioner, supra; Raynor v. Commissioner,

supra; Hafiz v. Commissioner, T.C. Memo. 1998-104.        But see Selfe

v. United States, 778 F.2d 769, 773 n.7 (11th Cir. 1985).

Guaranteeing a bank loan does not constitute an economic outlay

because the shareholder is only secondarily liable.       See Putnam

v. Commissioner, supra at 85.     A shareholder must perform under
                              - 9 -

the guaranty to increase basis in the S corporation.8    Perry v.

Commissioner, 392 F.2d 458 (8th Cir. 1968) (corporate debts

guaranteed by the shareholder were not debt whose basis is taken

into account for loss passthrough purposes).    But see Selfe v.

United States, supra (sole shareholder may get a basis increase

in stock if the loan was in fact made to him or her and borrowed

funds were re-lent to corporation).   Cf. Estate of Leavitt v.

Commissioner, 90 T.C. 206 (1988) (no basis increase for

shareholder-guaranteed loan to corporation; majority refused to

apply debt-equity principles to S corporation’s guaranteed loan,

rejecting Selfe).

     The shareholder in an S corporation therefore, generally,

may not increase his or her basis in the S corporation by simply

guaranteeing the debt of an S corporation.     Because petitioner

was not called upon to perform under the loan or make any

payment, we hold that his personal guaranty did not increase his

basis in Level Propane.

Pledged Collateral

     We next address whether petitioner’s pledge of stock of an S

corporation to secure the loan the bank made to the S corporation

constitutes an economic outlay.   We address, first, our caselaw,




     8
      By contrast, a limited partner who guarantees a nonrecourse
partnership debt may be allowed to increase basis.
                                  - 10 -

and, second, petitioner’s argument that the precedent in the

Eleventh Circuit compels a different result.9

       Courts have indicated that pledging personal assets is not

an economic outlay sufficient to increase basis.       See Harris v.

United States, 902 F.2d 439, 445 n.16 (5th Cir. 1990); see also

Calcutt v. Commissioner, supra at 719-720; Luiz v. Commissioner,

T.C. Memo. 2004-21.       But see Selfe v. United States, supra at 773

n.7.       Moreover, petitioner has offered no authority, other than

an ambiguous invocation of Eleventh Circuit precedent, that

pledging stock might constitute an economic outlay.10      Perhaps

petitioner is relying on Selfe, though he failed to cite the case

at trial or in brief.       This Court has previously disagreed with

the analysis in Selfe.       Estate of Leavitt v. Commissioner, 90

T.C. 206 (1988).       Nonetheless, we find the facts in Selfe


       9
      Presumably finding Eleventh Circuit precedent more
favorable to his position, petitioner claims he resided, at the
time he filed the petition, with his mother in Florida, which is
in the Eleventh Circuit, rather than with his wife in Ohio, which
is in the Sixth Circuit. See sec. 7482. Without deciding
whether petitioner resided in the Eleventh Circuit, we focus on
whether caselaw in the Eleventh Circuit would characterize
petitioner’s pledge of stock as an economic outlay that would
increase his basis in the S corporation.
       10
      A footnote states that a guarantor who has pledged stock
to secure a loan “has experienced an economic outlay” to the
extent that the pledged stock is not available as collateral for
other investments, because the guarantor has lost the time value
or use of his or her collateral. Selfe v. United States, 778
F.2d 769, 773 n.7 (11th Cir. 1985). Although petitioner failed
to bring this footnote to our attention, we read it in the
context of the facts in Selfe, which we distinguish.
                                - 11 -

distinguishable from the facts before us, and, hence, that case

is not controlling.

     We first note that the court in Selfe reaffirmed the

principle that “an economic outlay is required” before a

shareholder in an S corporation may increase his or her basis.

Selfe v. United States, supra at 772.     Selfe holds, however, that

a shareholder does not, in all circumstances, have to “absolve” a

corporation’s debt to increase basis.     Id. (citing Brown v.

Commissioner, 706 F.2d 755 (6th Cir. 1983)).     Selfe does not

compel a different conclusion, notwithstanding its holding,

because our facts are distinguishable.

     In Selfe, the taxpayer borrowed funds in her individual

capacity, then pledged her personal assets as collateral for a

loan.   Id. at 770.   The taxpayer later formed an S corporation

and advanced the borrowed funds to the S corporation.     Id.     The

taxpayer’s loan was, at that point, converted into a loan to the

corporation.    The corporation assumed the liability to repay the

loan, and the taxpayer guaranteed repayment if the corporation

did not repay.    The taxpayer’s personal assets continued to be

collateral for the corporate liability.     Id. at 771.

     Petitioner has offered no evidence that he personally

borrowed funds from the bank and then advanced those funds to

Level Propane, or that the bank looked primarily to him for

repayment.     In contrast, a bank employee in Selfe testified that
                              - 12 -

the bank looked to the taxpayer as primary obligor.    Id. at 774.

Petitioner has offered no analogous testimony, and we can infer

the testimony would have been adverse to petitioner.    See Wichita

Terminal Elevator Co. v. Commissioner, 162 F.2d 513, 515 (10th

Cir. 1947), affg. 6 T.C. 1158 (1946).

     The facts in our case indicate the bank looked primarily to

the S corporation for repayment, not petitioner.11    In Spencer v.

Commissioner, 110 T.C. at 85-86, where appeal lay to the Court of

Appeals for the Eleventh Circuit, Selfe was distinguished because

this Court was not persuaded the bank looked primarily to the

taxpayer for repayment, even though the taxpayer had pledged

personal assets as collateral.   Similarly, the collateral on

which the bank depended in this case belonged to the corporate

debtor, not petitioner.   Until the bank calls upon petitioner

individually to make some payment on the loan, petitioner has

experienced no economic outlay and may not increase his basis in

the S corporation.   Because petitioner has offered no evidence

that the bank looked primarily to him for repayment, we conclude

that Selfe is distinguishable and, therefore, does not control

this case.   See Metzger Trust v. Commissioner, 76 T.C. 42, 72-74

(1981) (factual distinctions render decision of Court of Appeals

     11
      Petitioner would garner a basis increase if, for example,
his pledged shares in the S corporation were foreclosed by the
bank and their value were applied toward the balance of the loan.
If that were to occur, petitioner would have incurred a cost and,
consequently, made an economic outlay.
                             - 13 -

not squarely on point and Golsen rule inapplicable), affd. 693

F.2d 459 (5th Cir. 1982); Golsen v. Commissioner, 54 T.C. 742,

756-757 (1970) (the Golsen rule requires the Court to follow a

Court of Appeals decision that is squarely on point if appeal

from its decision lies to that Court of Appeals), affd. 445 F.2d

985 (10th Cir. 1971).

Loss of Control

     Petitioner makes a third argument for increasing his basis

by the amount of the $4 million loan.    Petitioner argues that he

lost “control” of Level Propane and was therefore entitled to a

basis increase by the amount of the cost he associated with

losing control of the S corporation.    Petitioner has not

substantiated, however, any alleged loss of control.    Nor has

petitioner provided us with a means to value the loss of control.

Even had petitioner substantiated some transitory loss of

control, no basis-increasing event occurred.    Petitioner remained

at all times the owner of his shares.    We conclude that

petitioner has failed to show any economic outlay for his alleged

loss of control.

Form of the Transaction

     Finally, we address petitioner’s argument that we

recharacterize the form of the loan transaction as a loan to

himself that he then advanced to Level Propane.    Taxpayers are

ordinarily bound by the “form” of their transaction and may not
                               - 14 -

argue that the “substance” of their transaction triggers

different tax consequences.   See Don E. Williams Co. v.

Commissioner, 429 U.S. 569, 579 (1977); Commissioner v. Natl.

Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 149 (1974) (a

taxpayer must accept the tax consequences of his or her choice

and may not enjoy the benefit of some other route he or she might

have chosen to follow but did not); Selfe v. United States, 778

F.2d at 773; Brown v. Commissioner, supra; Framatome Connectors

USA, Inc. v. Commissioner, 118 T.C. 32, 47 (2002), affd. 108 Fed.

Appx. 683 (2d Cir. 2004).

     Petitioner was free to organize his affairs as he saw fit.

Once having done so, however, he must accept the tax consequences

of his choice and may not enjoy the benefit of some other

transaction.   See Commissioner v. Natl. Alfalfa Dehydrating &

Milling Co., supra at 149.    We therefore decline to adopt

petitioner’s view of the transaction.   The bank lent the funds to

the S corporation, not to petitioner, and the loan proceeds were

used to fund operations of the S corporation.

Conclusion

     We conclude that petitioner may not increase his basis in

the stock of Level Propane by the amount of the $4 million loan

the bank made to Level Propane.   Petitioner therefore had

insufficient basis in the stock of Level Propane to deduct
                             - 15 -

passthrough losses from Level Propane.   Accordingly, we sustain

respondent’s disallowance of those deductions during the years at

issue.


                                         Decisions will be entered

                                   for respondent.
