Tax Court Invokes Economic-Outlay Analysis for S Loans

In Cox,TC Memo 2001-196, the Tax Court used the "economic outlay" theory in determining whether S shareholders received a basis increase. In this case, one of three S shareholders (Christopher) and the S corporation jointly borrowed money from a bank, secured by property belonging to Christopher. Christopher and the S corporation treated the loan as Christopher's personal obligation to the bank. Christopher contributed some of the loan proceeds to the S corporation and made payments to the bank on the debt. The IRS apparently agreed that the line of credit was Christopher's personal obligation. After finding that Christopher transferred some of the loan proceeds to the S corporation, the court found that he was entitled to a basis increase for the proceeds transferred.

The other two shareholders argued that they also were entitled to a basis increase, claiming that they owned, along with Christopher, an interest in the property securing the loan. They never made any payments on the loan. The court found that their claimed ownership of the encumbered property was irrelevant under the economic-outlay theory. Under that theory, a shareholder has debt basis only to the extent he has actually parted with property or cash, or the S corporation has actually incurred a debt to the shareholder. A guaranty, surety, accommodation or any other form of indirect "borrowing" by an S shareholder does not create debt basis for that person. (For a discussion of the theory, see Porcaro, "Restructuring Debt Basis in Light of the 'Economic Outlay' Doctrine," TTA, Sept. 2001, p. 604.)

By Jeffrey A. Erickson, J.D., Washington, DC