                          T.C. Summary Opinion 2017-9



                         UNITED STATES TAX COURT



    WILLIAM H. TINSLEY AND AMARYLLIS E. TINSLEY, Petitioners v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 6698-14S.                          Filed February 28, 2017.


      William H. Tinsley & Amaryllis E. Tinsley, pro sese.

      Horace Crump, Thomas Alan Friday, and Edwin B. Cleverdon, for

respondent.



                              SUMMARY OPINION


      JACOBS, Judge: This case was heard pursuant to the provisions of section

7463 of the Internal Revenue Code in effect when the petition was filed. Pursuant

to section 7463(b), the decision to be entered is not reviewable by any other court,

and this opinion shall not be treated as precedent for any other case.
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      This case was submitted to the Court fully stipulated under Rule 122. The

sole issue in this case is whether Mr. Tinsley had a sufficient basis in Command

Computers of West Florida, Inc. (Command Computers), as of December 31,

2010, on account of his obligation with respect to the Command Computers’ debt,

to permit petitioners to deduct $110,480, which represented a portion of Mr.

Tinsley’s distributive share of Command Computers’ current and suspended

(2008) flowthrough losses, on their 2010 Form 1040, U.S. Individual Income Tax

Return. Unless otherwise indicated, all section references are to the Internal

Revenue Code, as amended, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

                                    Background

      At the time they filed their petition, petitioners resided in Florida. At all

relevant times Mr. Tinsley was the sole shareholder of Command Computers, a

corporation engaged in the business of computer design and service. Command

Computers elected S corporation status effective March 22, 2006.

      On April 5, 2006, Command Computers borrowed $150,000 from First City

Bank of Florida (Bank). Mr. Tinsley guaranteed the loan. Command Computers

was liquidated in August 2010. At the time of liquidation Command Computers

owed the Bank $110,480.
                                       -3-

      Command Computers timely filed its 2010 Form 1120S, U.S. Income Tax

Return for an S Corporation, on which it reported an ordinary business loss of

$136,243. Mr. Tinsley had no stock or debt basis in Command Computers when it

was liquidated.

      After Command Computers was liquidated, the operations of the business

continued under its former name. The legal form of the business was not indicated

in the record.

      Command Computers’ 2006 loan with the Bank was renewed on March 16,

2011. Command Computers of West Florida, Inc., remained the named borrower

of the renewed loan even though it no longer legally existed. Mr. Tinsley signed

the renewal note as president of Command Computers and was the guarantor of

the loan. The amount of the renewed loan was $104,771.86. Attached to the

renewal note was the original promissory note, dated April 5, 2006, on which a

handwritten notation stated: “Sec by--Inventory & Equipment”. The renewal note

provided that a final balloon payment was due on March 16, 2016. Mr. Tinsley

made all loan payments following the liquidation of Command Computers, but the

record does not indicate whether he made the payments from his personal funds or

merely signed checks drawn on the account of Command Computers.
                                         -4-

      Respondent examined petitioners’ 2010 tax return and disallowed the

$110,480 loss deduction related to Command Computers. On January 3, 2014,

respondent mailed petitioners a notice of deficiency. On Form 886-A, Explanation

of Items, attached to the notice of deficiency, respondent explained:

      Since your distributive share of the S Corporation Command
      Computers of West Florida, Inc. loss is limited to the extent of your
      adjusted basis, we have disallowed the amount in excess of your
      basis, your loss flow-through from your S Corporation is limited to
      your basis. Since you did not establish that the amount shown was (a)
      a loss, and (b) sustained by you, it is not deductible. The loss(es) you
      claimed cannot be allowed because it has not been established that
      you are at risk within the meaning of section 465 of the Internal
      Revenue Code in the amount of the claimed loss(es).

                                    Discussion

      As a general rule, the Commissioner’s determinations in the notice of

deficiency are presumed correct, and the taxpayer bears the burden of proving

error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Deductions

are a matter of legislative grace and are allowable only as specifically provided by

statute. See INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New

Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). Taxpayers bear the

burden of proving that they are entitled to any deductions claimed. New Colonial

Ice Co. v. Helvering, 292 U.S. at 440.
                                        -5-

      Section 1366(a)(1)(A) provides that an S corporation shareholder may take

into account his or her pro rata share of the corporation’s losses, deductions, or

credits. However, section 1366(d)(1) limits the aggregate amount of losses and

deductions the shareholder may take into account to the sum of (A) the adjusted

basis of the shareholder’s stock in the S corporation (arising from capital

contributions to the S corporation, see Nathel v. Commissioner, 131 T.C. 262

(2008), aff’d, 615 F.3d 83 (2d Cir. 2010)), and (B) the shareholder’s adjusted basis

in any indebtedness of the S corporation (often acquired by borrowing funds from

a third party and contributing the proceeds to the corporation, see Gleason v.

Commissioner, T.C. Memo. 2006-191).

      Mr. Tinsley concedes he had no stock or debt basis in Command Computers

at the time of its liquidation in 2010. However, he contends that upon the

liquidation, he assumed the balance due on the note as guarantor, and because he

was the sole remaining obligor, this assumption was a contribution to capital,

allowing him to deduct the amount of Command Computers’ losses. Further, Mr.

Tinsley asserts that following Command Computers’ liquidation, the Bank

expected him, as guarantor, to repay the loan and that the Bank’s expectation was

sufficient to generate a basis for Mr. Tinsley in Command Computers.
                                          -6-

      Merely guaranteeing an S corporation’s debt is not sufficient to generate a

basis under section 1366(d)(1)(B). Spencer v. Commissioner, 110 T.C. 62, 83

(1998); Estate of Leavitt v. Commissioner, 90 T.C. 206, 211 (1988), aff’d, 875

F.2d 420, 422 (4th Cir. 1989). In Raynor v. Commissioner, 50 T.C. 762, 770-771

(1968), we stated: “No form of indirect borrowing, be it guaranty, surety,

accommodation, comaking or otherwise, gives rise to indebtedness from the

corporation to the shareholders until and unless the shareholders pay part or all of

the obligation. Prior to that crucial act, ‘liability’ may exist, but not debt to the

shareholders.” Id. We also have said that a shareholder may obtain an increase in

basis in an S corporation only if there is an economic outlay on the part of the

shareholder that leaves him or her “poorer in a material sense.” Gleason v.

Commissioner, T.C. Memo. 2006-191, slip op. at 24 (quoting Perry v.

Commissioner, 54 T.C. 1293, 1296 (1970), aff’d without published opinion, 1971

WL 2651 (8th Cir. May 12, 1971)). “Stated otherwise, the shareholder must make

an actual ‘investment’ in the entity”. Id.

      We are mindful that the Court of Appeals for the Eleventh Circuit, to which

an appeal in this case would normally lie were this not a small tax case,1 has held

      1
       Because any appeal in this case, if it were permissible, would lie to the
Court of Appeals for the Eleventh Circuit, we follow the precedent established in
                                                                       (continued...)
                                          -7-

that a shareholder who has guaranteed a loan to an S corporation may increase his

or her basis where, in substance, the shareholder has borrowed funds and

subsequently advanced them to the corporation. Selfe v. United States, 778 F.2d

769, 773 (11th Cir. 1985). The Court of Appeals noted the general rule that an

economic outlay is required before a stockholder in an S corporation may increase

his or her basis, id. at 772, but held that this rule does not require “a

stockholder/taxpayer * * * [to] in all cases, absolve a corporation’s debt before she

may recognize an increased basis as a guarantor of a loan to a corporation”, id.

Observing that “where the nature of a taxpayer’s interest in a corporation is in

issue, courts may look beyond the form of the interest and investigate the

substance of the transaction”, id. at 774, and citing Plantation Patterns, Inc. v.

Commissioner, 462 F.2d 712 (5th Cir. 1972), aff’g T.C. Memo. 1970-182,2 the

Court of Appeals held that a shareholder’s guaranty of a loan to an S corporation



      1
        (...continued)
that circuit. See Golsen v. Commissioner, 54 T.C. 742, 756-757 (1970), aff’d, 445
F.2d 985 (10th Cir. 1971).
      2
       The U.S. Court of Appeals for the Eleventh Circuit was established on
October 1, 1981, pursuant to the Fifth Circuit Court of Appeals Reorganization
Act of 1980, Pub. L. No. 96-452, 94 Stat. 1994. In Bonner v. City of Prichard,
661 F.2d 1206, 1207 (11th Cir. 1981), that court adopted the decisions of the U.S.
Court of Appeals for the Fifth Circuit handed down before the close of business on
Sept. 30, 1981, as governing law in the Eleventh Circuit.
                                        -8-

“may be treated for tax purposes as an equity investment in the corporation where

the lender looks to the shareholder as the primary obligor.” Selfe, 778 F.2d at 774.

The Court of Appeals held that this determination is an “inquiry focused on highly

complex issues of fact and that similar inquiries must be carefully evaluated on

their own facts.” Id.3 In Selfe, the taxpayer presented the deposition testimony of

her loan officer stating that the bank looked primarily to the taxpayer and not the

corporation for repayment of the loan as well as evidence that the S corporation

was thinly capitalized.

      We now turn to the facts in this case to determine whether petitioners have

established that by the end of 2010 (1) the Bank looked to Mr. Tinsley for

repayment and (2) Mr. Tinsley made economic outlays in making those payments.

      Petitioners presented no evidence to support a finding that the Bank looked

primarily to Mr. Tinsley, as opposed to Command Computers, for repayment of

the loan.4 And we are mindful that petitioners concede that even after the


      3
       Selfe v. United States, 778 F.2d 769 (11th Cir. 1985), was before the Court
of Appeals on the taxpayer’s appeal of an order granting the Government’s motion
for summary judgment. The evidence introduced by the taxpayer raised the issue
of a material fact as to whether the shareholder was the primary obligor with
respect to the debt.
      4
        In petitioners’ pretrial memorandum they state that “in the examiner’s
report, she [the examiner] received ‘a statement from First City Bank, the debt
                                                                       (continued...)
                                         -9-

corporate liquidation, Command Computers remained an ongoing business

enterprise.

      We acknowledge that the stipulation of facts in this case states that “[t]he

petitioner continues to make payments on the loan”, but there is no indication that

the loan payments were made from Mr. Tinsley’s personal funds rather than

Command Computers’ funds with Mr. Tinsley signing payment checks as

president. Moreover, we are mindful that under the terms of the renewal note,

the renewed loan was to Command Computers and that Mr. Tinsley’s obligation

was that of a guarantor, not the maker of the loan. Further, we are mindful that the

promissory note for the 2006 loan, which was appended to the 2011 renewal note,

included a notation that the loan was secured by Command Computers’ inventory


      4
        (...continued)
holder,’ noting that Petitioner was the original guarantor on the loan.’” Petitioners
also assert that the examination report states that the examiner received a letter
from the Bank which stated: “Since the company folded in 2010, Mr. Tinsley
[Petitioner] has assumed the full responsibility for this loan and makes all
payments.” Petitioners’ pretrial memorandum also states: “First City Bank issued
a letter to the IRS appeals officer stating that * * * [the fact that the loan renewal
was made to the defunct Command Computers and not to Mr. Tinsley] was their
standard operating procedure” in cases “where the original obligor is no longer
active and we are now dealing with the person who was the original guarantor as
the only remaining primary debtor.”

      Despite their importance, none of these documents was entered into the
record. We therefore do not consider them in deciding this case.
                                       - 10 -

and agreement. Thus, we believe that (1) even after its liquidation Command

Computers continued to operate, and (2) the Bank continued to look to Command

Computers as the primary obligor on the loan and expected it to make the loan

repayments.

      Petitioners assert in their brief that the renewal of the loan to Command

Computers in 2011 does not affect their position that Mr. Tinsley became the

primary obligor of the loan upon Command Computers’ liquidation. “The bank,

as a matter of administrative convenience, chose to renew the note instead of

issuing a new note. The name on the note was that of the former S corporation, an

entity that no longer existed under state law. The Bank was aware of this and had

elected at the time of liquidation to leave the note in the corporate name.” Thus,

petitioners posit that Mr. Tinsley assumed the bank debt at the time of Command

Computers’ liquidation and that “his status as the sole remaining obligor”, for tax

purposes, caused the repayments of the loan to be treated as contributions to the

capital of Command Computers. Respondent disagrees, arguing that “upon the

Corporation’s liquidation, the debt remained undisturbed: the corporation did not

default on the debt, the terms of the debt were not altered, and payments on the

debt continued.”
                                       - 11 -

      There is insufficient evidence in the record to permit us to make, with

confidence, a finding that in both 2006 and 2011 the loan was made to Mr. Tinsley

personally, as opposed to Command Computers, and that Mr. Tinsley, as the

borrower, advanced the loan proceeds to Command Computers. Because

petitioners failed to establish that the Bank looked primarily to Mr. Tinsley to

satisfy the debt obligation or that Mr. Tinsley made an economic outlay with

respect to the loan, they failed to prove they had a basis in Command Computers

as of December 31, 2010, sufficient for them to deduct the reported business

losses.

      To reflect the foregoing,


                                                      Decision will be entered

                                                for respondent.
