Taking a Business Loss Deduction, Can You Prove Basis?

by Kenneth Hoffman in , ,

Loans made by a shareholder of his or her own funds, or those borrowed from an unrelated party and loaned directly to an S corporation increase basis.

In Yolanda Welch et al. (T.C. Memo. 2012-179) the taxpayer was an 80% shareholder in an S corporation (her husband had the remaining 20%) that provided respiratory and home healthcare services. Ms. Welch asserted that she borrowed some $600,000 from a doctor and lent all the funds to the corporation. The Court noted that all the funds, however, were either paid directly by the doctor to the corporation or else represented amounts that he charged to his credit card as payments for the corporation's expenses. The doctor wrote no checks to Ms. Welch. She contributed no personal funds to the corporation, nor did the corporation execute a loan agreement or any notes evidencing any loans from her.

Ms. Welch signed 27 promissory notes in favor of the doctor. The notes were for varying amounts totaling $598,197. The notes had various maturity dates, none more than a year after execution and were secured by receivables from the corporation; Ms. Welch did not offer any personal collateral. The corporation made some payments on the notes directly to the doctor. Ms. Welch reported no interest income or constructive dividends with respect to the payments. (The husband's situation was different, but he too could not prove his basis.)

The Court noted the taxpayers failed to show that on the relevant dates they had any remaining basis in the corporation; that it was impossible to reconcile the taxpayer's asserted bases as of yearends at issue with the corporations books and tax returns. The taxpayers admitted that in the corporation's early years they did not consistently keep contemporaneous records of basis. The Court sided with the IRS in disallowing the taxpayers' claimed passthrough losses. The Court also held the taxpayers failed to show the burden of proof shifted to the IRS.

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