                Case: 18-11909       Date Filed: 05/06/2019       Page: 1 of 18


                                                                                    [PUBLISH]

                   IN THE UNITED STATES COURT OF APPEALS

                            FOR THE ELEVENTH CIRCUIT
                              ________________________

                                     No. 18-11909
                               ________________________

                                   Agency No. 001795-13



HOMERO F. MERUELO,

                                                                         Petitioner-Appellant,

versus

COMMISSIONER OF INTERNAL REVENUE,

                                                                        Respondent-Appellee.

                               ________________________

                         Petition for Review of a Decision of the
                                 United States Tax Court
                               ________________________

                                        (May 6, 2019)

Before WILLIAM PRYOR and NEWSOM, Circuit Judges, and VRATIL, * District
Judge.

WILLIAM PRYOR, Circuit Judge:



*
 Honorable Kathryn H. Vratil, United States District Judge for the District of Kansas, sitting by
designation.
              Case: 18-11909    Date Filed: 05/06/2019   Page: 2 of 18


      This appeal from the disallowance of a taxpayer’s claimed deduction for his

share of losses suffered by an S corporation presents the following issue: whether

monetary transfers between various business entities partly owned by the taxpayer

and an S corporation that were later reclassified as loans from the taxpayer to the S

corporation established a “bona fide indebtedness” that “runs directly” to the

taxpayer. Treas. Reg. § 1.1366-2(a)(2)(i); see also 26 U.S.C. § 1366. Homero

Meruelo was a shareholder of Merco of the Palm Beaches, Inc., which suffered a

nearly $27 million loss after banks foreclosed on its condominium complex.

Meruelo asserted that he had a sufficient basis in Merco’s indebtedness for him to

deduct $13 million as his share of the loss. Meruelo claimed basis from a $5

million capital contribution he made to Merco and more than $9 million of

indebtedness from net transfers through various other business entities in which he

held an interest. The Internal Revenue Service determined that he could claim only

the $5 million basis and not the $9 million because any debt ran from Merco to the

other entities. The Tax Court later ruled that Meruelo had failed to establish a bona

fide indebtedness of $9 million running directly to him and that he failed to

establish that he made an “actual economic outlay” toward the debt. Because the

Tax Court correctly determined that Meruelo did not establish a bona fide

indebtedness that ran directly to him, we affirm.




                                          2
              Case: 18-11909    Date Filed: 05/06/2019   Page: 3 of 18


                               I. BACKGROUND

      Meruelo, a real estate developer in south Florida, owns interests in several S

corporations, partnerships, and limited liability companies. One of these entities

was Merco of the Palm Beaches, Inc., an S corporation Meruelo incorporated in

March 2004. Meruelo held 49 percent of Merco’s stock.

      Subchapter S of the Internal Revenue Code provides “a pass-through system

under which corporate income, losses, deductions, and credits are attributed to

individual shareholders in a manner akin to the tax treatment of partnerships.”

Buffered v. Comm’r, 506 U.S. 523, 525 (1993). A shareholder’s ability to deduct

his proportionate share of a corporation’s net operating losses is limited by the sum

of his basis in his stock and the corporate indebtedness to him. See 26 U.S.C.

§ 1366(d)(1). In other words, the shareholder can increase his basis by contributing

capital to the corporation or by lending money to it.

      Meruelo incorporated Merco to purchase a condominium complex in a

bankruptcy sale. In early 2004, the bankruptcy court approved the sale and

required Merco to pay a $10 million non-refundable deposit to secure the property.

To raise funds for his share of the deposit, Meruelo obtained a personal loan.

      Meruelo transferred $4,985,035 of the loan proceeds to Merco Group at

Akoya, an S corporation in which he and his mother each held a 50 percent

interest. In March 2004, Akoya transferred into Merco’s escrow account $5



                                          3
              Case: 18-11909      Date Filed: 05/06/2019   Page: 4 of 18


million—$4,985,035 of Meruelo’s loan proceeds and $14,965 of Akoya’s own

funds—to cover half the required deposit. Akoya had also previously transferred to

Merco enough funds to cover the $5 million balance of the deposit. The

Commissioner does not dispute that the $4,985,035 transfer gave Meruelo a

shareholder basis in that amount in Merco.

      From 2004 to 2008, Merco entered into hundreds of transactions with

various partnerships, S corporations, and limited liability companies in which

Meruelo held an interest. These Merco affiliates often paid expenses, such as

payroll costs, for each other or for Merco to simplify accounting and enhance

liquidity. The payor company recorded these payments to its affiliates as accounts

receivable, and the payee company recorded them as accounts payable. Between

2004 and 2008, Merco affiliates made more than $15 million in payments to or on

behalf of Merco, and Merco repaid its affiliates less than $6 million of these

payments. On December 31 of each year, Merco’s books and records showed

substantial net accounts payable to its affiliates.

      Luis Carreras, a certified public accountant, prepared the tax returns filed by

Meruelo, Merco, and the Merco affiliates. When preparing Merco’s tax return for a

given year, Carreras would net Merco’s accounts payable to its affiliates, as shown

on Merco’s books as of the preceding December 31, against Merco’s accounts

receivable from its affiliates. If Merco had net accounts payable, Carreras reported



                                            4
              Case: 18-11909      Date Filed: 05/06/2019   Page: 5 of 18


that amount as a “shareholder loan” on Merco’s tax return. Carreras then allocated

a percentage of this indebtedness to Meruelo based on Meruelo’s ownership

interests in the various affiliates that had transferred funds to Merco.

      In March 2004, Carreras drafted a promissory note for Meruelo purportedly

to make a $10 million unsecured line of credit available to Merco at a six percent

interest rate. Carreras testified that, when he prepared Meruelo’s and Merco’s tax

returns for tax years 2004 to 2008, he made an annual charge to Merco’s line of

credit for an amount equal to Meruelo’s calculated share of Merco’s net accounts

payable to its affiliates for the preceding year.

      In 2008, Merco incurred a loss of $26,605,840 when banks foreclosed on the

condominium complex it purchased in 2004. Merco reported this loss on its

income tax return, and Merco allocated 49 percent of the loss to Meruelo.

      Meruelo filed income tax returns for 2005 and 2008. On his 2005 return, he

reported taxable income of $13,895,731 and tax due of $4,843,976. On his 2008

return, he claimed an ordinary loss deduction of $11,795,109. This deduction

reflected a $13,036,861 flow-through loss from Merco ($26,605,840 × 49 percent)

netted against gains of $1,241,752 from two other S corporations in which he held

interests. After accounting for other income and deductions, Meruelo reported a net

operating loss of $11,793,865 on his 2008 return. In October 2009, he applied for a

tentative refund asserting a net operating loss carryback of $11,793,865 from 2008



                                           5
              Case: 18-11909     Date Filed: 05/06/2019    Page: 6 of 18


to 2005. After applying this net operating loss carryback, his original tax lability

for 2005, $4,843,976, was reduced by $3,897,470, to $946,506. In January 2010,

the Internal Revenue Service issued Meruelo a refund of $3,897,470.

      The Internal Revenue Service selected Meruelo’s 2005 and 2008 returns for

examination. It determined that his basis in Merco was only $4,985,035 based on

the proceeds of the bank loan that Meruelo contributed to Merco through Akoya. It

disallowed, for lack of a sufficient basis, $8,051,826 of the $13,036,861 flow-

through loss claimed for 2008.

      After disallowing part of the net operating loss for 2008, the Commissioner

determined that Meruelo’s carryback to 2005 was limited to $3,706,272 and that

his correct tax due for 2005 was $3,546,781. Because Meruelo had reported a tax

liability of only $946,506 for 2005, the Commissioner concluded that Meruelo’s

tax deficiency for that year was $2,600,275 and sent Meruelo a notice of

deficiency.

      Meruelo petitioned the Tax Court for redetermination of his tax deficiency.

He alleged that he had a sufficient basis in Merco for him to fully deduct his share

of its 2008 losses. Meruelo alleged that his basis in Merco consisted of $2.7

million of Akoya’s first deposit of $5 million, all $5 million of Akoya’s second

deposit, and $6,616,857 for his share of intercompany transfers.




                                           6
             Case: 18-11909     Date Filed: 05/06/2019   Page: 7 of 18


      Meruelo offered two theories to claim credit for the affiliated companies’

transfers to Merco: the “back-to-back loan” theory and the “incorporated

pocketbook theory.” Under the back-to-back-loan theory, he argued the affiliated

companies should have been treated as lending funds to him that he then lent to

Merco. And under the incorporated-pocketbook theory, Meruelo argued that he

should have been treated as using his funds, which were held by the affiliated

companies, to pay Merco’s expenses on his behalf.

      After a trial, the Tax Court ruled for the Commissioner. The Tax Court

acknowledged that Meruelo had an undisputed basis of $4,985,035 in Merco, and it

explained that only $8,051,826 of the $13,036,9861 flow-through loss was in

dispute. But the Tax Court determined that Meruelo was not entitled to any of the

disputed basis.

      The Tax Court explained that section 1366(d)(1)(B) of the Internal Revenue

Code allows a shareholder to increase his basis by the amount of the adjusted basis

of any indebtedness owed by the S corporation to the shareholder. Because the

Code “does not specify how a shareholder may acquire basis in an S corporation’s

indebtedness to him,” the Tax Court turned to the legislative history of the

predecessor to section 1366 for guidance. The Tax Court explained that earlier

decisions relied on this legislative history and construed language about “a

shareholder’s investment in a corporation” to require an “actual economic outlay”



                                          7
              Case: 18-11909     Date Filed: 05/06/2019   Page: 8 of 18


by the shareholder. In other words, the Tax Court ruled that a shareholder must

show that he incurred a cost in making a loan or that he was left poorer in a

material sense after the transaction.

      The Tax Court decided that the test for determining a shareholder’s basis in

an S corporation under Treasury Regulation § 1.1366-2(a)(2)—which was

amended in 2014 and limits debt basis to “bona fide indebtedness of the S

corporation that runs directly to the shareholder”—was effectively the same as that

under the “actual economic outlay” doctrine. The Tax Court explained that it had

long required that a shareholder prove an S corporation’s indebtedness running

directly to him to deduct his proportionate share of the corporation’s net operating

loss. And the Tax Court reasoned that because the 2014 regulation states that

“bona fide indebtedness” is to be determined by “general Federal tax principles,”

the 2014 regulation incorporates the actual economic outlay doctrine.

      The Tax Court rejected Meruelo’s back-to-back-loan theory because there

was no evidence that funds had been lent to Meruelo and then lent back to Merco.

The Tax Court acknowledged that bona fide back-to-back loans, first from an

affiliated company to a shareholder and then from the shareholder to the debtor S

corporation, can increase a shareholder’s basis. But it explained that a shareholder

is bound by the form of the transaction he initially chose and that transactions

directly among related companies (and not involving the shareholder) do not



                                          8
             Case: 18-11909     Date Filed: 05/06/2019   Page: 9 of 18


qualify as back-to-back loans. The Tax Court clarified that a taxpayer-shareholder

cannot reclassify intercompany loans as shareholder loans for tax purposes when

preparing his return. The Tax Court then ruled that, because there was no evidence

that the Merco affiliates had contemporaneously booked transfers between them as

shareholder loans—the affiliates instead labeled them as accounts receivable and

payable, wage payments, or capital contributions—Meruelo’s back-to-back-loan

theory failed. The Tax Court also ruled that, because Meruelo made no actual

economic outlay toward the monetary transfers from the Merco affiliates to Merco,

he could not claim that these transfers amounted to a shareholder loan.

      The Tax Court likewise rejected Meruelo’s incorporated-pocketbook theory.

The Tax Court explained that, although some of its rulings allowed basis increases

under an incorporated-pocketbook theory, the facts here were a “far cry” from

those decisions. The Tax Court explained that in other incorporated-pocketbook

decisions, the taxpayer habitually used a single, wholly owned corporation to pay

third parties on his behalf. But many of the Merco affiliates had co-owners besides

Meruelo, and Meruelo had not shown that these affiliates had a “habitual practice”

of paying his personal expenses. And the Tax Court explained that the

“incorporated pocketbook” corporations contemporaneously booked the

disbursements as shareholder loans. The Merco affiliates, by contrast, booked their

transactions as capital contributions, payroll expenses, or intercompany accounts



                                         9
             Case: 18-11909      Date Filed: 05/06/2019    Page: 10 of 18


payable and receivable, and only relabeled the disbursements as shareholder loans

at the close of each year. The Tax Court upheld the Commissioner’s determination

of a $2,600,275 deficiency.

                           II. STANDARD OF REVIEW

      We “review the decisions of the Tax Court . . . in the same manner and to

the same extent as decisions of the district courts in civil actions tried without a

jury.” 26 U.S.C. § 7482(a)(1). “The interpretation of a statutory section of the

Internal Revenue Code by the tax court is a question of law reviewed de novo.”

McLaulin v. Comm’r, 276 F.3d 1269, 1272 (11th Cir. 2001).

                                 III. DISCUSSION

      Section 1366 permits a shareholder of an S corporation to deduct his pro

rata share of a net operating loss sustained by the corporation:

      (a) Determination of shareholder’s tax liability.—
            (1) In general.—In determining the tax under this chapter of a
            shareholder for the shareholder’s taxable year in which the
            taxable year of the S corporation ends . . . , there shall be taken
            into account the shareholder’s pro rata share of the
            corporation’s—
                   (A) items of income (including tax-exempt income), loss,
                   deduction, or credit the separate treatment of which could
                   affect the liability for tax of any shareholder, and
                   (B) nonseparately computed income or loss.
      ...
      (d) Special rules for losses and deductions.—
            (1) Cannot exceed shareholder’s basis in stock and debt.—
            The aggregate amount of losses and deductions taken into
            account by a shareholder under subsection (a) for any taxable
            year shall not exceed the sum of—


                                           10
             Case: 18-11909     Date Filed: 05/06/2019   Page: 11 of 18


                   (A) the adjusted basis of the shareholder’s stock in the S
                   corporation . . . , and
                   (B) the shareholder’s adjusted basis of any indebtedness
                   of the S corporation to the shareholder . . . .

26 U.S.C. § 1366. Under section 1366(a)(1), an S corporation’s income and

operating losses are passed through to its shareholders in a similar way to the tax

treatment of partnerships. Buffered, 506 U.S. at 525; Ellinger v. United States, 470

F.3d 1325, 1329 n.2 (11th Cir. 2006). A shareholder may deduct his portion of an

S corporation’s net operating losses only to the extent that the loss does not exceed

the sum of “the adjusted basis of the shareholder’s stock in the S corporation,” 26

U.S.C. § 1366(d)(1)(A), and “the shareholder’s adjusted basis of any indebtedness

of the S corporation to the shareholder,” id. § 1366(d)(1)(B). This appeal concerns

only a shareholder’s adjusted basis of indebtedness under section 1366(d)(1)(B).

      Meruelo argues, and the Commissioner agrees, that the governing

regulation, Treas. Reg. § 1.1366-2, as amended in 2014, provides a standard of

“bona fide indebtedness” that must run “directly to the shareholder” for

determining a shareholder’s debt basis in an S corporation:

      (2) Basis of indebtedness—(i) In general. The term basis of any
      indebtedness of the S corporation to the shareholder means the
      shareholder’s adjusted basis . . . in any bona fide indebtedness of the S
      corporation that runs directly to the shareholder. Whether indebtedness
      is bona fide indebtedness to a shareholder is determined under general
      Federal tax principles and depends upon all of the facts and
      circumstances.




                                         11
             Case: 18-11909     Date Filed: 05/06/2019   Page: 12 of 18


Treas. Reg. § 1.1366-2(a)(ii)(2) (emphasis added). The Commissioner also agrees

that this regulation applies to Merco’s losses for the 2005 and 2008 tax years

because those tax years were still open for assessment in July 2014. See id. §

1.1366-5(b) (explaining that the regulation applies “with respect to indebtedness

between an S corporation and its shareholder that resulted from any transaction

that occurred in a year” that was still open for assessment on July 23, 2014).

      An S corporation’s debt does not run directly to the shareholder if it instead

flows through “an entity with passthrough characteristics which advanced the

funds and is closely related to the taxpayer.” Hitchins v. Comm’r, 103 T.C. 711,

715 (1994). But the 2014 regulation provides that if a shareholder engages in

genuine “back-to-back” loans—in which an affiliated entity loans the shareholder

funds that he then loans directly to the S corporation—those loans can establish

bona fide indebtedness running directly to the shareholder. See Treas. Reg.

§ 1.1366-2(a)(2)(iii) (“Example 2. Back-to-back loan transaction. A is the sole

shareholder of two S corporations, S1 and S2. S1 loaned $200,000 to A. A then

loaned $200,000 to S2 . . . If A’s loan to S2 constitutes bona fide indebtedness

from S2 to A, A’s back-to-back loan increases A’s basis of indebtedness in

S2 . . . .”). So to claim a deduction under section 1366(a), Meruelo had to establish

that a bona fide indebtedness of Merco ran directly to him.




                                         12
             Case: 18-11909     Date Filed: 05/06/2019    Page: 13 of 18


      Meruelo presents two alternative arguments that the Tax Court erred in

disallowing his deduction. First, he contends that Merco’s debt ran directly to him

under a back-to-back-loan theory. Second, he contends that the debt ran directly to

him under an incorporated-pocketbook theory. Both arguments fail.

  A. Meruelo’s Back-to-Back-Loan Theory Fails Because Merco’s Debt Ran to
                       the Merco Affiliates, Not to Meruelo.

      Meruelo argues that he can claim a debt basis based on his back-to-back-

loan theory for two reasons. First, he argues that we should treat the monetary

transfers between the Merco affiliates as back-to-back loans based on the economic

substance of the transactions rather than the form they took. Second, he

alternatively contends that the form of the transactions was sufficient to establish

that they amounted to back-to-back loans.

      Meruelo’s argument for substance over form is a nonstarter. Taxpayers are

ordinarily “liable for the tax consequences of the transaction they actually execute

and may not reap the benefit of some other transaction that they might have made.”

Selfe v. United States, 778 F.2d 769, 773 (11th Cir. 1985). “In other words,

taxpayers ordinarily are bound by the ‘form’ of their transaction and may not argue

that the ‘substance’ of their transaction triggers different tax consequences.” Id.

The Supreme Court has explained that although “a taxpayer is free to organize his

affairs as he chooses, nevertheless, once having done so, he must accept the tax

consequences of his choice, whether contemplated or not, and may not enjoy the


                                          13
             Case: 18-11909      Date Filed: 05/06/2019    Page: 14 of 18


benefit of some other route he might have chosen to follow but did not.” Comm’r

v. Nat’l Alfalfa Deyhdrating & Milling Co., 417 U.S. 134, 149 (1974) (citations

omitted).

      The parties cite, and we are aware of, only a single decision in which we

have agreed with a taxpayer that an exceptional circumstance could warrant

looking to the substance of a transaction instead of its form as having a different

tax consequence. See Selfe, 778 F.2d at 774. The taxpayer-shareholder in Selfe had

initially obtained a loan in her individual capacity to fund her fledgling retail

clothing business and pledged her personal assets as collateral. See id. at 770. At

the bank’s request, she agreed to convert her loan into one from the bank to the S

corporation where she guaranteed the corporation’s indebtedness to the bank and

continued to pledge her assets as collateral. Id. at 770–71. We concluded that, in

the light of the circumstances suggesting that the bank looked to the shareholder as

the primary obligor on the loan instead of the thinly capitalized S corporation,

genuine issues of material fact existed as to whether the guaranteed loan was

effectively a back-to-back loan through the shareholder. Id. at 774–75. We

remanded to determine whether the shareholder’s guaranty amounted to either a

shareholder loan or an equity investment. Id. at 775.

      Nothing akin to the exceptional circumstance in Selfe occurred here. Only an

“unusual set[] of facts” can warrant judging a transaction based on its substance



                                          14
                Case: 18-11909   Date Filed: 05/06/2019   Page: 15 of 18


instead of its form. Sleiman v. Comm’r, 187 F.3d 1352, 1359 (11th Cir. 1999)

(refusing to extend the approach from Selfe to treat a shareholder-guaranteed loan

to an S corporation as if it were a back-to-back loan where the lender looked to the

shareholder as only a secondary obligor). Meruelo’s argument about the substance

of his transaction—that a portion of the funds the affiliates transferred to Merco

could be considered profits that Meruelo was otherwise entitled to receive and that

the funds were used to pay Merco’s business expenses—hardly presents an

“unusual set of facts” about intercompany monetary transfers, and it does not

justify setting aside our ordinary rule that the taxpayer is bound by the form his

transactions. See Shebester v. Comm’r, 53 T.C.M. (CCH) 824 (1987) (rejecting

taxpayer’s contention that loans from one controlled S corporation to another

controlled S corporation were in substance a series of dividends to the shareholder

from one corporation followed by loans from the shareholder to the other

corporation).

      Meruelo also argues that his accountant’s end-of-year reclassification of the

intercompany transfers, as reflected on his tax returns and on the annual

adjustments to the line-of-credit from the 2004 Note, were sufficient to establish

that the transactions amounted to shareholder, but we disagree. “After-the-fact

reclassification cannot satisfy the requirement that the debt run directly from the S

corporation to the taxpayer/shareholder, and courts have previously rejected efforts



                                          15
             Case: 18-11909     Date Filed: 05/06/2019    Page: 16 of 18


by taxpayers to establish debt basis in an S corporation using this method.” Broz v.

Comm’r, 727 F.3d 621, 627 (6th Cir. 2013); Ruckriegel v. Comm’r, 91 T.C.M.

(CCH) 1035 (2006) (ruling that yearend reclassification of intercorporate loans as

back-to-back loans through the taxpayer was insufficient to provide debt basis);

Burnstein v. Comm’r, 47 T.C.M. (CCH) 1100 (1984) (same). Because the

transactions were contemporaneously classified as transactions between the

affiliates and Merco, the designation Meruelo’s accountant gave them at the end of

the year does not govern. And we agree with the Tax Court that the accountant’s

adjustments to “a notional line of credit, uniformly made after the close of each

relevant tax year, do not suffice to create indebtedness to [Meruelo] where none in

fact existed.”

     B. Meruelo’s Incorporated-Pocketbook Theory Fails Because the Merco
                 Affiliates Were Not His Incorporated Pocketbook.
      Meruelo alternatively contends that he can claim debt basis based on his

incorporated-pocketbook theory. This theory holds that “[a] taxpayer can obtain

debt basis in an S corporation through payments made by a wholly owned

corporate entity if that entity functions as the shareholder’s ‘incorporated

pocketbook,’ meaning that the taxpayer has a ‘habitual practice of having his

wholly owned corporation pay money to third parties on his behalf.’” Broz, 727

F.3d at 627–28 (citation omitted). In two decisions, the Tax Court has ruled that

payments made to an S corporation by a taxpayer’s “incorporated pocketbook”


                                          16
             Case: 18-11909    Date Filed: 05/06/2019    Page: 17 of 18


company were sufficient to establish the shareholder’s debt basis. See Yates v.

Comm’r, 82 T.C.M. (CCH) 805 (2001); Culnen v. Comm’r, 79 T.C.M. (CCH)

1933 (2000), rev’d on other grounds, 28 F. App’x 116 (3d Cir. 2002).

      Even if we assume that the incorporated-pocketbook theory comports with

the requirement that a debt run “directly to the shareholder,” Meruelo failed to

establish that the Merco affiliates constituted his incorporated pocketbook. Unlike

the shareholders in Yates and Culnen—who used a single, wholly owned entity to

pay third parties on the shareholder’s behalf—Meruelo seeks to treat eleven

distinct Merco affiliates, many of which he only partially owned, as his

incorporated pocketbook. Many of the Merco affiliates acted more like ordinary

business entities than as incorporated-pocketbook companies because they both

disbursed and received funds for business expenses from Merco. As the Tax Court

explained, no court has ever ruled that a group of non-wholly owned entities that

both receive and disburse funds in this fashion can constitute an incorporated

pocketbook. And Meruelo failed to establish that he habitually paid third parties on

his behalf through the putative incorporated-pocketbook companies. Meruelo’s

evidence established only that the Merco affiliates regularly paid the expenses of

other companies within the affiliate group—not his personal expenses. See Broz,

727 F.3d at 628 (affirming Tax Court’s rejection of taxpayers’ “incorporated

pocketbook” argument where the taxpayers failed to establish that they habitually



                                         17
            Case: 18-11909    Date Filed: 05/06/2019   Page: 18 of 18


paid third parties through the entities); Messina v. Comm’r, 114 T.C. Memo. 2017-

213, at *32–33 (2017) (rejecting theory on the same ground); Ruckriegel, 91

T.C.M. (CCH) 1035 (same).

                              IV. CONCLUSION

      We AFFIRM the judgment of the Tax Court in favor of the Commissioner.




                                       18
