Shareholder loan documentation.

• Author: Wong, Alan

Once again the Tax Court reminds taxpayers of the importance of details and following document terms for shareholder loans (Todd, T.C. Memo. 2011-123). The court determined that an amount purportedly borrowed by the sole shareholder of a corporation from its welfare benefit fund was a taxable distribution to the shareholder and not a loan.

The taxpayer was an employee and sole shareholder of the corporation. He was also its president and director. The corporation also employed several other individuals. All employees were covered under a collective bargaining agreement. The corporation, under the terms of the union contract, provided a death-benefit-only plan funded by life insurance through a welfare benefit fund. The taxpayer applied for and obtained a $6 million insurance policy on his life on behalf of the welfare fund. The welfare fund owned the policy, and the corporation paid the annual premiums. The welfare fund agreement provided that the employer and trustees of the plan had discretion to make loans to participants on a nondiscriminatory basis. Employees were required to submit an application and written evidence of serious financial hardship or a financial emergency. The taxpayer applied for a loan, stating on his application that he was experiencing "unexpected housing costs," and obtained a $400,000 loan from the welfare fund. The welfare fund elected to reduce the face amount of the taxpayer's policy in lieu of paying the 4.76% interest rate to the insurance company.

The welfare fund issued a note to the taxpayer that was not signed until six months after the loan was issued. The note provided for interest at market rates; however, the taxpayer was charged only 1 % interest. The note also provided that in lieu of the required quarterly loan note payments, the taxpayer could elect to reduce any payment from the fund to the taxpayer or his beneficiary. The taxpayer had not made any payments on the note.

In its opinion, the Tax Court looked to a Fifth Circuit decision--Moore, 412 F.2d 974 (5th Cir. 1969)--which held that "the distinguishing characteristic of a loan is the intention of the parties that the money advanced be repaid." Factors considered by courts in finding a bona fide loan are whether:

* The promise to repay was evidenced by a note or other instrument;

* Interest was charged;

* A fixed schedule for repayment was established;

* Collateral was given to secure payment;

* Repayments were made;

* The borrower had a...