                          T.C. Memo. 2004-21



                       UNITED STATES TAX COURT



                  GARY AND JANET LUIZ, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 6344-02.                   Filed January 29, 2004.


     Anthony V. Diosdi, for petitioners.

     Patricia Montero and Margaret S. Rigg, for respondent.


               MEMORANDUM FINDINGS OF FACT AND OPINION


     COLVIN, Judge:    Respondent determined deficiencies in

petitioners’ Federal income tax of $47,116 for 1996 and $23,475

for 1997.1


     1
        Respondent also determined that petitioners are liable
for the addition to tax for late filing under sec. 6651(a)(1) for
1996. Respondent now concedes that issue.
     Unless otherwise specified, section references are to the
Internal Revenue Code as amended. Rule references are to the Tax
Court Rules of Practice and Procedure. References to petitioner
are to Gary Luiz.
                               - 2 -

     Petitioner, a shareholder in Green Valley Sawmills, Inc.

(Green Valley), an S corporation, guaranteed to creditors of

Green Valley that he would repay Green Valley’s debts if Green

Valley did not repay them.   After concessions, the sole issue for

decision is whether an amount equal to those guaranties is

included in petitioner’s basis in his Green Valley stock.    We

hold that petitioner’s basis does not include the amount of those

guaranties.

                         FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

A.   Petitioners

     Petitioners are married and resided in Windsor, California,

when they filed their petition in this case.   Petitioner had been

in the business of purchasing logs, timber land, and lumber for

more than 25 years as of the time of trial.

B.   Green Valley Sawmills

     In 1995, petitioner, Richard Priest, and Dean Rose formed

Green Valley, an S corporation, to provide a livelihood for

themselves.   Petitioner contributed capital of about $27,000 to

Green Valley when it was formed.   Petitioner was president of

Green Valley.   Petitioner owned one-third of the stock of Green

Valley in 1996 and 42.03 percent of the stock in 1997.

     Green Valley bought logs from Hanes Ranch, Inc. (Hanes

Ranch), Miller Trust, Charles Hyatt, Gregg Koppala, Koppala Cook,
                                - 3 -

Koppala Aalfs, and others.    In 1996, Green Valley owed

$130,395.80 to Hanes Ranch, $119,883.80 to Miller Trust,

$77,378.15 to Koppala Cook, and $88,435.54 to Koppala Aalfs.

     Northern California Log Scaling and Grading Bureau measured

and graded logs delivered to Green Valley.    Green Valley paid for

logs based on those measurements and grades.

     Petitioner orally guaranteed Green Valley’s creditors,

including Hanes Ranch, Miller Trust, Charles Hyatt, Koppala Cook,

Koppala Aalfs, and Northern California Log Scaling and Grading

Bureau, that he would pay Green Valley’s debts if Green Valley

did not.   Those creditors expected petitioner to pay those debts

if Green Valley did not.

     Shuster’s Transportation hauled logs for Green Valley during

the winter of 1995-96.   Marvin W. Lawrence was part owner of

Shuster’s Transportation.    Green Valley owed about $17,000 to

Shuster’s Transportation for services Shuster’s Transportation

provided during that period.

     Petitioner made no payments to any of Green Valley’s

creditors in 1996 or 1997.    In 1998, petitioner issued a

promissory note to Shuster’s Transportation to pay Green Valley’s

debt.   Petitioner paid Shuster’s Transportation about $19,000

($500 per month beginning in 1998) under the terms of that note.
                              - 4 -

C.   Petitioners’ Income Tax Returns and Respondent’s
     Determination

     Petitioners filed Federal income tax returns for 1996 and

1997 and an amended return for 1996.   Petitioners deducted losses

from Green Valley of $234,945 for 1996 and $193,920 for 1997.

     Respondent determined that petitioner’s basis in Green

Valley stock was $23,965 in 1996 and $7,499 in 1997, and that

petitioners’ deduction of losses from Green Valley is limited to

the amount of that basis.

                             OPINION

A.   Background and Petitioners’ Position

     Petitioners contend that petitioner’s basis in Green Valley

stock includes amounts of Green Valley’s debts he guaranteed.

     A shareholder of an S corporation may deduct his or her pro

rata share of the S corporation’s losses, but the deduction may

not exceed the sum of the shareholder’s adjusted basis in his or

her stock and the shareholder’s adjusted basis in any

indebtedness of the S corporation to the shareholder.   Sec.

1366(d)(1)(A) and (B).

     A taxpayer using the cash method of accounting generally may

not increase the basis in his or her S corporation stock in the

amount of a guaranty until the taxpayer makes an actual economic

outlay (i.e., a payment) under the guaranty.   Goatcher v. United

States, 944 F.2d 747, 751 (10th Cir. 1991); Estate of Leavitt v.

Commissioner, 875 F.2d 420, 422 (4th Cir. 1989), affg. 90 T.C.
                               - 5 -

206 (1988); Spencer v. Commissioner, 110 T.C. 62, 83-84 (1998),

affd. without published opinion 194 F.3d 1324 (11th Cir. 1999);

Perry v. Commissioner, 54 T.C. 1293, 1296 (1970), affd. 27 AFTR

2d 71-1464, 71-2 USTC par. 9502 (8th Cir. 1971); Raynor v.

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

     Petitioners bear the burden of proof.2   Rule 142(a)(1).

B.   Whether Selfe v. United States Controls This Case

     Petitioners rely on Selfe v. United States, 778 F.2d 769,

772-774 (11th Cir. 1985), in which the U.S. Court of Appeals for

the Eleventh Circuit held that, in certain circumstances, a

shareholder's basis in S corporation stock includes the amount of

the shareholder’s guaranty of a loan to the S corporation, even

though the shareholder has not satisfied any of the obligation.

Id. at 774.

     We have previously stated our disagreement with the

reasoning in Selfe v. United States, supra.   Estate of Leavitt v.

Commissioner, 90 T.C. 206, 216 (1988), affd. 875 F.2d 420 (4th

Cir. 1989).   Even if we had not done so, we disagree with

petitioner’s contention that the circumstances in this case are

similar to those in Selfe.




     2
        Petitioners do not contend that respondent bears the
burden of proof under sec. 7491. Taxpayers bear the burden of
proving that the requirements under sec. 7491(a) are met. H.
Conf. Rept. 105-599, at 239 (1998), 1998-3 C.B. 747, 993; S.
Rept. 105-174, at 45 (1998), 1998-3 C.B. 537, 581.
                                       - 6 -

       The taxpayer in Selfe borrowed funds in her individual

capacity and pledged her personal assets as collateral.           Id. at

770.       She later formed an S corporation and advanced the borrowed

funds to the corporation.        Id.     The taxpayer’s loan was converted

into a loan to the corporation.          The corporation assumed the

liability for repayment of 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.   The U.S. Court of Appeals for the

Eleventh Circuit held that shareholder guaranties of subchapter S

corporate indebtedness increase the shareholder's tax basis in

his or her stock in the corporation where, in substance, the

shareholder borrowed funds and advanced them to the corporation.3

Id.    Unlike Selfe, there is no evidence in this case that

petitioner personally borrowed funds and then advanced those

funds to Green Valley or that he pledged personal assets as

collateral or that creditors of Green Valley looked primarily to

him for repayment.      We conclude that Selfe v. United States,

supra, is distinguishable and does not control this case.4


       3
        Because material facts in Selfe v. United States, 778
F.2d 769 (11th Cir. 1985), remained in dispute, the U.S. Court of
Appeals for the Eleventh Circuit 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.
       4
            Because Selfe does not control here, we need not decide
                                                       (continued...)
                                 - 7 -

C.   Whether Section 752(a) Applies

     Petitioners contend that, under section 752(a) and the

regulations thereunder, petitioner’s basis is increased by the

amount of the Green Valley debt that he guaranteed.5    Petitioners

acknowledge that Green Valley is an S corporation, and contend

that section 752(a) applies because S corporations are similar to

partnerships.   We disagree because section 752(a) applies to

partnerships, not to S corporations.     See, e.g., Smith v.

Commissioner, 84 T.C. 889, 909 (1985), affd. without published

opinion 805 F.2d 1073 (D.C. Cir. 1986).

D.   Whether Petitioner Made an Economic Outlay Before or During
     1996-97

     Petitioners contend that petitioner made an economic outlay

relating to Green Valley’s debts before or during 1996-97.     We

disagree for reasons stated next.




     4
      (...continued)
petitioners’ contentions that Selfe v. United States, supra, is
binding in cases appealable to the U.S. Court of Appeals for the
Ninth Circuit or that public policy considerations require
following Selfe in this Court.
     5
         Sec. 752(a) provides:

         SEC. 752. TREATMENT OF CERTAIN LIABILITIES.

          (a) Increase in Partner’s Liabilities.--Any increase in
     a partner’s share of the liabilities of a partnership, or
     any increase in a partner’s individual liabilities by reason
     of the assumption by such partner of partnership
     liabilities, shall be considered as a contribution of money
     by such partner to the partnership.
                               - 8 -

     1.   Whether Petitioner Is Deemed To Have Pledged Property
          as Collateral Based on Section 3054 of the California
          Civil Code

     Petitioners contend that petitioner’s guaranty of Green

Valley debt was an economic outlay under section 3054 of the

California Civil Code (West 1993).     Section 3054 of the

California Civil Code grants a lending institution a general lien

on all property in its possession belonging to customers.6

Petitioners contend that, under section 3054 of the California

Civil Code, Green Valley’s creditors could have filed a general

lien on petitioner’s personal property while petitioner’s

guaranties were in effect.   We disagree.    Section 3054 of the

California Civil Code applies to banks and savings and loan

associations.   None of Green Valley’s creditors were banks or




     6
        Sec. 3054 of the California Civil Code (West 1993)
provides:

     SEC. 3054. BANKER'S OR SAVINGS AND LOAN ASSOCIATION'S
     LIEN; DEPOSIT ACCOUNTS.

               (a) A banker, or a savings and loan
          association, has a general lien, dependent on
          possession, upon all property in his or her
          hands belonging to a customer, for the
          balance due to the banker or savings and loan
          association from the customer in the course
          of the business.

               (b) The exercise of this lien with
          respect to deposit accounts shall be subject
          to the limitations and procedures set forth
          in Section 864 or 6660 of the Financial Code.
                                 - 9 -

savings and loan associations.    Thus, section 3054 of the

California Civil Code does not apply here.

     2.     Whether Petitioner Is Deemed To Have Pledged Property
            as Security Based on Bloom v. Bender

     Petitioners contend that petitioner’s guaranty of Green

Valley debt was an economic outlay under Bloom v. Bender, 48 Cal.

2d 793 (1957).    Petitioners contend that, under Bloom, the

obligation of a guarantor is presumed to be unconditional, and a

guarantor is liable on the default of the primary obligor without

notice or demand.   Petitioners contend that petitioner’s

guaranties amount to an unconditional obligation which

effectively results in a general lien on petitioner’s personal

property.    Thus, petitioners contend that petitioner made an

economic outlay to the extent that his personal property was

unavailable as collateral for other investments.     Petitioners’

reliance on Bloom is misplaced.

     The plaintiff in Bloom sued the guarantor to enforce a

written surety agreement after default by the principal debtor.

The California Supreme Court held that the obligation of the

guarantor is not barred by the running of the statute of

limitations against the principal debtor or the discharge of the

principal debtor in bankruptcy.     Id. at 798.   The California

Supreme Court did not discuss or decide whether the guarantor

pledged collateral or whether there was an economic outlay by the

guarantor.   We conclude that Bloom does not apply here.
                               - 10 -

     3.   Whether Petitioner’s 1998 Promissory Note to Shuster’s
          Transportation Was an Economic Outlay in 1996-97

     Petitioners contend that petitioner may increase his basis

in Green Valley for 1996-97 in the amount of the payments made on

his 1998 note to Shuster’s Transportation because he signed that

note pursuant to his guaranty, which was in effect in 1996-97,

and that this constituted an economic outlay in 1996-97.

Petitioners contend that petitioner’s basis includes the amount

of the guaranty because petitioner’s guaranty made him poorer in

a material sense in 1996-97.   Petitioners contend that petitioner

could not responsibly sell or use his personal assets as

collateral (other than for his guaranty to Green Valley’s

creditors) in those years, and that doing so would have violated

his obligation under the guaranty.      We disagree.

     Petitioner did not make an economic outlay under the

guaranty in 1996-97.   A taxpayer/shareholder makes an economic

outlay when he or she is left poorer in a material sense after

the transaction.   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); Underwood v.

Commissioner, 63 T.C. 468, 477 (1975), affd. 535 F.2d 309 (5th

Cir. 1976); Perry v. Commissioner, 54 T.C. 1293, 1296 (1970);

Horne v. Commissioner, 5 T.C. 250, 254 (1945).         Petitioner’s

voluntary refusal, if any, to sell or use personal assets was not

a pledge of those assets, nor did it constitute an expenditure of
                              - 11 -

funds or leave petitioner poorer in a material sense.   Even if

petitioner had pledged those assets as collateral for his

guaranty, courts have held that pledging of personal assets is

not an economic outlay sufficient to increase basis.    See, e.g.,

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

Calcutt v. Commissioner, 84 T.C. 716, 719-720 (1985).

Petitioners offer no authority for the proposition that

petitioner’s belief that he could not sell or use his personal

assets as collateral in 1996-97 was an economic outlay for

purposes of increasing his basis in Green Valley stock.   We

conclude that petitioner’s self-imposed restriction did not

increase his basis in Green Valley stock.

E.   Conclusion

     We conclude that petitioner may not increase his basis in

his Green Valley stock in 1996-97 by the amount of his guaranties

to Green Valley creditors.   Petitioner had insufficient basis in

his stock and debt in Green Valley to allow him to deduct the

losses claimed on petitioners’ 1996-97 returns.   We sustain
                               - 12 -

respondent's disallowance of losses from Green Valley in 1996-

97.7

       To reflect concessions and the foregoing,



                                               Decision will be

                                          entered under Rule 155.




       7
        Thus, we sustain respondent’s determination that
petitioner’s basis in Green Valley was $23,965 for 1996 and
$7,499 for 1997.
