                     United States Court of Appeals
                             FOR THE EIGHTH CIRCUIT
                                       ___________

                                       No. 98-2104
                                       ___________


Larry Bergman; Patricia Bergman,           *
                                           *
             Plaintiffs - Appellees,       *
                                           *   Appeal from the United States
v.                                         *   District Court for the
                                           *   District of Minnesota.
United States of America,                  *
                                           *
             Defendant - Appellant.        *
                                           *

                                       ___________

                              Submitted: February 11, 1999
                                 Filed: April 19, 1999
                                  ___________

Before McMILLIAN, JOHN R. GIBSON, and MURPHY, Circuit Judges.
                            ___________

MURPHY, Circuit Judge.

      Larry and Patricia Bergman, husband and wife, brought this tax refund suit
against the United States to recover certain amounts they paid for the 1990 tax year
because of a disallowed deduction for operating losses of one of several corporations
owned or controlled by Larry Bergman. The district court granted their motion for
summary judgment, and the United States appeals. We reverse and remand.
                                         I.

       During 1990 Larry Bergman was the president and owner of three S
corporations: Advanced Flex, Inc. (AFI), AF2, Inc. (AF2), and AF3, Inc. (AF3).1 Each
corporation had its own manufacturing plant at a separate site and its own employees.
AFI was started in 1976, and Bergman incorporated AF2 in 1984. These two
companies manufactured rigid multilayer printed circuit boards, and both had been
profitable in most years. AFI focused on medium-to-large quantity production runs
while AF2 specialized in smaller or more experimental orders. AF3 was established
in 1989, primarily with assets purchased from Honeywell. AF3 manufactured flexible
printed circuit boards and was never profitable. Its revenues in 1990 did not cover
costs, and it sustained a loss of $1,512,917 for the year.

       AF3 received a number of cash infusions from Bergman and from AF2.
Bergman made an initial capital contribution of $20,000 to AF3 in November 1989, and
later that month lent it $5000. In December 1989 he advanced $50,000 to the
corporation, and he also loaned it an additional $150,000 during February and March
of 1990. Bergman drew on a $200,000 personal line of credit at Marquette Bank to
finance most of these advances. AF2 also made cash advances to AF3 during 1990
and received notes in return. The loans from AF2 to AF3 totaled $1,690,000 by
December 20, 1990, and unpaid interest accrued on them.

       Near the end of 1990, Bergman was advised that he would not be able to deduct
all of AF3’s losses on his personal income tax return because his basis in the
corporation was insufficient. Under the Internal Revenue Code a taxpayer can only


      1
       Bergman owned all of the voting stock of AF2 and AF3 and approximately
97.5 percent of the voting stock of AF1. It appears that his sons owned additional
non-voting stock in AFI and AF2 but that there was no non-voting stock in AF3.
                                         2
increase his basis in an S corporation by adding capital or loaning money to it. I.R.C.
§ 1366(d). The $1,690,000 debt AF3 owed to AF2 did not affect Bergman’s basis in
AF3 because it did not run directly to him. In order to increase his personal basis in
AF3, Bergman arranged a series of transactions on December 20, 1990 to restructure
the debt the corporation owed AF2. First, AF3 issued checks totaling $1,690,000 to
AF2 to repay the loans it had made during 1990. Next, AF2 loaned Bergman the same
amount, issuing him checks for $780,000 and $910,000 and receiving notes from him
in return. Finally, Bergman wrote checks to AF3 for $780,000 and $910,000 and it
issued notes of indebtedness to him. Thus, when all the transactions were concluded,
AF3 owed the $1,690,000 debt to Bergman instead of to AF2, and the Bergmans
deducted this amount as an operating loss on their 1990 tax return.

       All of the December 20 checks were drawn on accounts maintained at Marquette
Bank by Bergman and the two corporations. The funds cleared simultaneously during
that day’s account reconciliation, and at the end of the day the same amount of funds
was in each account as at the beginning of the day. AF3’s books reflected its
indebtedness to Bergman, and interest was accrued on the loan but not paid. Interest
was also accrued on the AF2 loans and was eventually paid off in full in 1992.

       AF3 continued to face financial troubles during 1991. Bergman made some
additional loans to it during the course of that year, and then on December 31 he
contributed to AF3’s capital several notes the corporation had given him, including the
$780,000 and $910,000 notes of December 20, 1990.2 Also on December 31, 1991
Bergman used a $200,000 distribution he received from AF2 to pay back to the
company approximately one year’s worth of interest on the loans he had received
from it.



      2
      After the contribution to capital, AF3’s remaining debt to Bergman was
$214,761.67.
                                          3
        Bergman executed a major corporate restructuring during 1992, and sometime
during that year the Internal Revenue Service (IRS) began to examine the December
20, 1990 transactions more closely.3 On July 1, 1992 Bergman consolidated his three
corporations into one and paid off several outstanding debts. AF3 borrowed money
from AFI to pay Bergman interest of $287,813 on its outstanding debts. AFI paid a
$2,533,387 dividend to Bergman who in turn repaid AF2 $2,768,507.01 in loans and
interest. This transaction settled all amounts owed on the notes for $780,000 and
$910,000 given on December 20, 1990. AF3, which had never become profitable, was
dissolved after its assets were transferred to AFI in return for AFI’s assumption of its
liabilities. In addition, AF2 was merged into AFI, creating a single S corporation for
accounting and tax purposes. Following the restructuring, AFI continued to operate
the businesses and plants formerly owned by AF2 and AF3, but in 1996 the assets
which had belonged to AF3 were sold.

       The Bergmans deducted operating losses of $1,512,917 for AF3 on their 1990
personal income tax return. The IRS disallowed most of this deduction in its 1992
audit on the theory that the December 20 transactions had not increased Bergman’s
basis in AF3 and the couple was therefore not entitled to deduct the full amount.4
Additional tax of $378,360 plus $168,446 in interest was assessed. The auditor
reasoned that Bergman had made no actual economic outlay during the December
transactions and they thus could not have increased his basis in AF3. The auditor
requested technical assistance, and the national office of the IRS issued a technical




      3
        It is not clear exactly when the IRS investigation began, but there is a letter
in the record from Bergman’s accountant, dated June 16, 1992, responding to IRS
queries regarding the December 20, 1990 transactions.
      4
       $1,358,288 of the deduction was disallowed.
                                           4
advice memorandum5 which concluded that under the economic outlay doctrine
Bergman’s basis had not been increased.

       The Bergmans paid the tax and interest due, and then filed an administrative
claim for a refund. After six months elapsed with no action, they filed suit in the
district court to compel a refund in accordance with I.R.C. §§ 6531(a)(1) and 7422.
After discovery and briefing, they moved for summary judgment. The government
argued that the December 20 transactions had no economic substance as there had
been no actual outlay of Bergman’s funds.6 It also argued that summary judgment
would be improper because evidence had been presented sufficient for a reasonable
factfinder to infer that the loans had not been intended to be repaid and thus were not
genuine.




      5
        A technical advice memorandum is a statement of the IRS position
regarding a specific set of facts; it may not be cited as precedent. I.R.C. § 6110(b),
(j)(3).
      6
        The Bergmans have suggested that the government has changed its
argument on appeal, abandoning the position that there was no actual economic
outlay and arguing instead that the December 20 transactions did not have any
economic substance. These are not distinct theories, however, but rather the same
argument presented at different levels of generality. Loan transactions, like all
transactions, must have independent economic substance to confer tax benefits on
the parties. See, e.g., Knetsch v. United States, 364 U.S. 361, 364-65 (1960). The tax
benefits of creating indebtedness thus may be set aside if the taxpayer’s economic
situation has not actually changed. See, e.g., Drobny v. Commissioner, 86 T.C.
1326, 1346 (1986), Karme v. Commissioner, 73 T.C. 1163, 1186-87 (1980), aff’d,
673 F.2d 1062 (9th Cir. 1982). Actual indebtedness is created only where there is
an economically significant change in the taxpayer’s wealth; in other words, there
must be an actual economic outlay that leaves the taxpayer poorer in a material
sense. See, e.g., Perry v. Commissioner, 54 T.C. 1293, 1295-96 (1970), aff’d, 1971
WL 2651 (8th Cir.).
                                           5
       The district court concluded that undisputed facts established that the December
20, 1990 transactions increased Bergman’s basis in AF3 and that the government had
not presented facts to show the transactions were anything other than valid loans. It
cited in support Gilday v. Commissioner, 43 T.C.M. (CCH) 1295 (1982) (shareholders
acquired basis in their S corporation by restructuring a bank loan to the corporation),
and it reasoned that the economic outlay doctrine was a “guaranty” doctrine
inapplicable to a “loan” case and that the government’s reliance on Underwood v.
Commissioner, 535 F. 2d 309 (5th Cir. 1976), was therefore misplaced. The court
granted the Bergmans’ motion and ordered the government to refund to them income
taxes and interest paid for 1990 after recalculating their tax liability based upon a tax
basis in AF3 increased by the $1,690,000 loan.

      The government appeals from the judgment and argues the court should find
that Bergman’s basis was not increased as a matter of law and that it is entitled to
judgment or remand the case for further proceedings. It asserts that genuine issues of
material fact prevent summary judgment for the Bergmans and that questions remain
whether the December 20 transactions were genuine and whether they had sufficient
economic substance to increase Bergman’s basis in AF3. The taxpayers respond that
undisputed facts establish that as a matter of law Bergman’s December 20 checks to
AF3 increased his basis in the corporation.

                                           II.

       Summary judgment is reviewed de novo and is only proper if, viewing the
evidence in the light most favorable to the non-moving party, there are no genuine
issues of material fact and the moving party is entitled to judgment as a matter of law.
Fed. R. Civ. P. 56; Celotex Corp. v. Catrett, 477 U.S. 317, 322-23 (1986). An issue is
material if it could affect the outcome of the case under the applicable substantive law,
and a genuine issue is raised when the evidence presented in the district court is “such


                                           6
that a reasonable jury could return a verdict for the nonmoving party.” Anderson v.
Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). All inferences and credibility
determinations must be made in favor of the non-moving party. Id. at 255; Lundell
Mfg. Co. v. American Broad. Cos., 98 F.3d 351, 358 n.2 (8th Cir. 1996).

        Subchapter S of the Internal Revenue Code provides that a small business may
choose to have its profits and losses allocated pro rata to its shareholders and reported
on their individual income tax returns rather than pay corporate income tax. I.R.C. §
1366(a). Corporations making elections under this subchapter essentially function as
“pass-through” entities for tax purposes; however, S corporation losses may only be
deducted to the extent a shareholder has basis in the corporation. I.R.C. § 1366(d).
This limitation prevents a shareholder from deducting more than he has invested in the
corporation. See S. Rep. No. 85-1983 (1958), reprinted in 1958 U.S.S.C.A.N. 4791,
5008. Basis in an S corporation may be acquired either by contributing capital or
directly lending funds to the company.7 I.R.C. § 1366. No basis is created for a
shareholder, however, when funds are advanced to an S corporation by a separate
entity, even one closely related to the shareholder. Golden v. Commissioner, 61 T.C.



      7
       I.R.C. § 1366(d)(1) provides that:

             The aggregate amount of losses and deductions taken into account by
             a shareholder under subsection (a) [allows shareholders to deduct their
             pro rata shares of an S corporation’s loss] for any taxable year shall
             not exceed the sum of—
                    (A) the adjusted basis of the shareholder’s stock in the S
                    corporation . . .
                    (B) the shareholder’s adjusted basis of any indebtedness of the
                    S corporation to the shareholder . . .

Losses that cannot be deducted in one year may be carried over indefinitely. I.R.C.
§ 1366(c).
                                            7
343 (1973) (partnership); Prashker v. Commissioner, 59 T.C. 172 (1972) (estate);
Burnstein v. Commissioner, 47 T.C.M. (CCH) 1100 (1984) (S corporation).


       The parties agree that AF3 was an S corporation with losses in excess of $1.5
million in 1990 and that the loans which AF2 had made to AF3 did not increase
Bergman’s basis in AF3, but the key question is whether the December 20 loan
restructuring did increase his basis. The government argues that the December 20
transactions did not create basis because they did not have any real economic
consequences and did not involve an actual outlay of Bergman’s funds. At a
minimum, it argues, there are real factual disputes regarding whether the loans from
AF2 to Bergman and from him to AF3 were genuine, that is whether or not at the time
they were made the parties intended to enforce them. The taxpayers respond that
summary judgment was properly granted because undisputed facts show that
Bergman loaned $1.69 million to AF3 and thus increased his basis in the corporation.
In their view, the $1,690,000 loaned by AF2 to AF3 earlier in 1990 was actually
Bergman’s money and the December 20 transactions merely corrected a mistake in the
way the loan had been originally structured. The original loans from AF2 to AF3 were
in substance loans from Bergman to AF3 because he wholly owned AF2 and it was
actually his money that was placed at risk. They acknowledge that basis in AF3 was
not created for Bergman when the original loan from AF2 to AF3 was made, but argue
that this was only because the transaction did not comply with the form requirements
of § 1366. After the restructuring, the loans ran directly from Bergman to AF3 so the
form requirements were satisfied and additional basis in AF3 had been created for
Bergman. They further argue that the economic outlay doctrine is not an obstacle to
their recovery because Bergman made an actual payment of $1,690,000 to AF3.

       As a general rule a transaction must have a purpose, substance, or utility beyond
creating a tax deduction for it to have that tax effect. Knetsch v. United States, 364
U.S. 361, 365-67 (1960); Gregory v. Helvering, 293 U.S. 465, 469-70 (1935). Tax


                                           8
minimization is not an improper objective of corporate management, but transactions
may be disregarded if they are not actually what they are claimed to be. Haberman
Farms Inc. v. United States, 305 F.2d 787, 791(8th Cir. 1962). In line with this general
rule, a stockholder must make an actual economic outlay to increase his basis in an S
corporation. Reser v. Commissioner, 112 F.3d 1258, 1264 (5th Cir. 1997); see also
Selfe v. United States, 778 F.2d 769, 772 (11th Cir. 1985); Underwood v.
Commissioner, 535 F.3d 309 (5th Cir. 1976); Hitchins v. Commissioner, 103 T.C. 711,
715 (1994). A taxpayer claiming a deduction must show it was based on “‘some
transaction which when fully consummated left the taxpayer poorer in a material
sense.’” Perry v. Commissioner, 54 T.C. 1293, 1296 (1970), aff’d, 1971 WL 2651 (8th
Cir.) (citation omitted).

      The economic outlay doctrine does not apply only to loan guarantees, but it has
been used to explain that a shareholder who guarantees a bank loan to an S
corporation does not create additional basis because he is only secondarily and
conditionally liable. See Putnam v. Commissioner, 352 U.S. 82, 85 (1956); Uri v.
Commissioner, 949 F.2d 371, 373-74 (10th Cir. 1991); Brown v. Commissioner, 706
F.2d 755, 757 (6th Cir. 1983). But see Selfe v. United States, 788 F.2d 769 (11th Cir.
1985). The principle underlying the doctrine extends beyond such circumstances to
transactions which purport to be direct loans. See, e.g., Underwood,535 F.3d 309 (no
basis created by an exchange of notes rearranging loan of funds from a C corporation
to an S corporation). Transactions which are purported to create loans from
shareholders to S corporations do not create basis if there has been no actual outlay of
the shareholder’s funds. See Reser v. Commissioner, 112 F.3d 1258, 1264 (5th Cir.
1997) (“It is well established that a shareholder cannot increase his basis in his S
corporation stock without making a corresponding economic outlay.”); see also
Wilson v. Commissioner, 62 T.C.M. (CCH) 1122 (1991); Shebester v. Commissioner,
53 T.C.M. (CCH) 824 (1987); Burnstein v. Commissioner, 47 T.C.M. (CCH) 1100
(1984).


                                           9
       It is possible for a loan made as part of a loan restructuring to create additional
basis under § 1366(d) since any genuine increase in indebtedness adds basis. For
example, basis was created when a shareholder, who had previously only guaranteed
a loan to an S corporation, borrowed funds in an arm’s length transaction from a bank
and then loaned them to the corporation. Gilday v. Commissioner, 42 T.C. M. (CCH)
1295 (1985). The involvement of an independent third party lender was critical to the
result because there is no question that a lender such as a bank intends to force
repayment, truly placing the shareholder’s money at risk. When all of the entities
involved in a transaction are owned by a single individual, however, it may be unclear
whether the shareholder or the corporation is placed at risk. Cf. Underwood v.
Commissioner, 535 F.2d 309, 312 (5th Cir. 1976). The rationale of the cases has placed
“a heavy burden on shareholders who seek to rearrange the indebtedness of related
closely held S corporations.” Bhatia v. Commissioner, 72 T.C.M. (CCH) 696 (1996).
The existence of a close relationship between the parties to the transaction “is not
necessarily fatal if other elements are present which clearly establish the bona fides of
the transactions and their economic impact.” Id.


       The Fifth Circuit was faced with a factual situation similar to this case in
Underwood v. Commissioner, 535 F.2d 309 (5th Cir. 1976). In Underwood, a
transaction restructured a loan originally made from a C corporation owned by the
taxpayers to an S corporation which also belonged to them. The S corporation first
surrendered $110,000 worth of the C corporation’s notes and marked them paid. The
taxpayers then gave the S corporation their personal demand note for $110,000 and
they received from the C corporation a demand note for the same amount. The Fifth
Circuit held that no basis had been created in the taxpayers because it was not clear
that they would ever have had to repay the loan to the C corporation. Until they
actually paid the debt, they could not be said to have made an additional investment
that would increase their adjusted basis. Id. at 312. The fact that no new funds were
actually advanced was further evidence that the loans were not genuine. Id. Other


                                           10
courts have similarly emphasized that a loan to an S corporation does not create basis
in taxpayers when it is not clear that their money is in fact at risk. Brown v.
Commissioner, 706 F.2d 755, 756-57 (6th Cir. 1983); Hafiz v. Commissioner, 75 T.C.M
1982 (CCH) (1998).

       On the taxpayers’ motion for summary judgment, the facts and the inferences
 from them must be viewed in favor of the government. Anderson v. Liberty Lobby,
Inc., 477 U.S. 242, 255 (1986). When the undisputed facts are viewed in favor of the
government, it is not clear that the loans created on December 20 were genuine.
Although Bergman ultimately repaid the loans to him from AF2, the evidence
construed in favor of the government does not show that he intended to do so at the
time of the transaction. Bergman testified in his deposition that he could not recall if
any collateral secured the loans and that he never intended to enforce his loan to AF3
by foreclosing on any collateral in the event of a default. The only actual economic
outlay may have been the original loans from AF2 to AF3 since the subsequent
transactions could be viewed as merely a series of offsetting entries among bank
accounts held in the same bank by entities controlled by Bergman. On the Bergmans’
motion for summary judgment, it cannot be held that Bergman’s actual indebtedness
was increased. When the evidence is viewed in the light most favorable to the
government, material issues remain whether on December 20, 1990 Bergman intended
to repay the loan to AF2, and whether he gave money to AF3 on that day which made
him poorer in a material sense. On this record summary judgment should not have
been granted to the taxpayers.

       Accordingly, the judgment is reversed and the case is remanded to the district
court for further proceedings.

      A true copy.



                                          11
ATTEST:

    CLERK, U.S. COURT OF APPEALS, EIGHTH CIRCUIT.




                  12
