Guarantor Primarily Liable for Note Could Deduct Related Accrued Interest.

• Author: Fiore, Nicholas J.

In 1983, G began managing a weekly business publication (EBN) as a sole proprietorship. In 1987, G incorporated EBNI, an S corporation in which G was the sole shareholder.

P was G's friend and financial backer. Over the years, they transacted business through a variety of con-trolled entities. In 1988, G executed a 60-day note to a trust of which P was a trustee and the sole beneficiary. This note consolidated several outstanding loans between G and P. It was signed by G and secured by all of EBNI's stock.

In 1992, EBNI filed for bankruptcy protection under Chapter 11. In the bankruptcy petition schedules, G did not list the note. At no time did the trust demand payment on the note. On his 1993 and 1994 returns, G claimed a deduction for accrued interest relating to the note and a net operating loss carryover. The IRS denied these deductions, but the Tax Court (in a memorandum opinion) held that G could take these deductions.

Accrued Interest Deduction

The IRS determined that, because EBNI was the primary obligor and G merely a guarantor, G was not entitled to a deduction relating to accrued interest on the note. G contends that he was the obligor and therefore entitled to the deductions.

Sec. 163(a) allows as a deduction all interest paid or accrued within the tax year on indebtedness. A guarantor who becomes the primary obligor on the liability can deduct...