TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Sunday, August 28, 2005

Tax Court Allows S Corp Shareholder to Pump Up Basis with Year-End Loan Repaid 3 Days Later

Tax_court_7 Joe Kristan has a thoughtful analysis of Brooks v. Commissioner, T.C. Memo. 2005-204, decided on Thursday:

S corporation shareholders have to have "basis" in either their stock or in loans they have personally made (not just guaranteed!) in their S corporation. The Tax Court [on Thursday] allowed S corporation owners to take losses for year-end loans made to their corporation, even though they took the money back out only a few days later.

The two shareholders each advanced $800k to the S Corp on 12/31/99. which was repaid three days later and followed by additional $1.1m loans on 12/29/00.  The S Corp had losses of $883k in 1999 and $828k in 2000, which the Tax Court held were fully supported by the shareholder loans.  Joe cautions us not to read too much into the Tax Court's decision:

Notwithstanding the taxpayer victory here, we normally wouldn't advise taxpayers to put large amounts of cash into an S corporation right before year-end to take losses and then withdraw it right after year-end. The IRS has other tools they could use to attack such short loans, and those attacks might succeed under other circumstances. They might attack the loan as lacking substance, for example, especially if the check didn't clear before it was repaid; this would be a twist on the Oren case. Or they might say the taxpayer wasn't really "at-risk" for the loan over such a short period, especially if the lent funds were borrowed from a related party as in Van Wyk. If a deduction for the losses is important, you should at least let the money you put into your S corporation at year-end cool down for a few weeks before you take it back out. Even if you win ultimately, it's easier to win if the IRS isn't tempted to come after you in the first place. While the taxpayers won [on Thursday], they'd have been happier if they didn't have to go to Tax Court at all.

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