Shareholder Guarantee to S Corporation Creditors Doesn't Increase Basis
According to IRC section 1366(d) the aggregate amount of losses and deductions an S corporation shareholder may take into account for any taxable year may not exceed the sum of the adjusted basis of the shareholder's stock in the S corporation and the shareholder's adjusted basis in any amount the corporation owes the shareholder. Taxpayers generally may not increase the basis in their S corporation stock by the amount of a loan guaranty to S corporation creditors until they make an actual "economic outlay." In a recent case the court considered whether an S corporation shareholder could include the amount of the guaranteed debt in his stock basis. Gary Luiz and two other shareholders formed Green Valley Sawmills Inc., an S corporation, in 1995. Luiz contributed approximately $27,000 in capital and was the corporation's president and one-third owner. By 1997 Luiz owned 43.03% of Green Valley. Green Valley in 1996 owed approximately $416,093 for logs it had purchased and $17,000 for transportation services provided to it in 1995 and 1996. Luiz orally guaranteed Green Valley's creditors he would pay the debts if the company did not. Luiz did not make any payments to Green Valley creditors during 1996 or 1997, but in 1998 he issued a promissory note to pay the corporation's transportation debt. He paid about $19,000 under the terms of the note. Luiz filed federal income tax returns for 1996 and 1997 deducting losses from Green Valley of $234,945 and $193,920, respectively. The IRS determined that Luiz's basis in his Green Valley stock was $23,965 in 1996 and $7,499 in 1997 and that his deduction of the S corporation's losses should have been limited to the amount of that basis. Luiz's position was that he had made an economic outlay relating to Green Valley's debts before or during 1996 to 1997. He advanced the following arguments in support of this contention: * His basis in Green Valley stock included the amount of Green Valley's debts he had guaranteed. Relying on Selfe v. United States, (86-1 USTC 9115), Luiz argued he could increase his basis in Green Valley by the amount of his guarantees to the 8 corporation's creditors. In Selfe the court held that shareholder guarantees of S corporation indebtedness increased the shareholder's tax basis in his or her stock where, in substance, the shareholder personally borrowed funds and advanced them to the corporation. * Relying on Bloom v. Bender, 48 Cal. 2d 793 (1957), Luiz contended a guarantor's obligation is presumed to be unconditional and he or she is liable on the default of the primary obligor without notice or demand. …