Contributions increase shareholders' S corporation basis.

• Author: Beavers, James A.

The Tax Court held that shareholders in two related S corporations could increase their basis in one of the corporations by contributing assets to it that they had received in a distribution from the other corporation.

Background

James and Joy Maguire and their son, Marc, and his wife, Pamela, (the Maguires) owned two S corporations whose businesses were related: one an auto dealership, the other a finance company that purchased customer notes from the auto dealership. During the years in issue, the finance company operated at a profit and the auto dealership operated at a loss. The Maguires did not have sufficient bases in the auto dealership to deduct its losses. However, they had substantial bases in the finance company.

At the end of each year, the finance company owned substantial accounts receivable due from the dealership. At the end of each yea; the Maguires received distributions of the accounts receivable from the finance company and then contributed them to the related dealership to increase their bases in the dealership enough to allow for the deduction of its losses. On audit, the IRS disallowed the claimed loss deductions, asserting that the Maguires' actions did not increase their bases in the dealership because the Maguires did not make an economic outlay in the transactions between them and their related S corporations. The Maguires challenged the IRS's determination in Tax Court.

The Tax Court's Decision

The Tax Court held that the Maguires could deduct the losses from the auto dealership because they made a basiscreating economic outlay when they contributed the accounts receivable from the finance company to the auto dealership. The court found that the distribution and contributions of the accounts receivable actually did take place and that they had real consequences that altered the positions of the Maguires individually and those of their businesses.

With regard to whether the distributions and contributions took place, the court found sufficient evidence that they had. At trial, James and Marc Maguire testified that their accountants had advised them to effectuate the accounts receivable transactions at the end of the years in question, and a partner from the accounting firm testified that he had given this advice. This testimony, along with corporate resolutions and adjusting journal entries on the corporate books, convinced the court that the distributions and contributions took place as the Maguires claimed.

The...