S shareholders cannot increase bases using corporate debt.

• Author: Kautter, David J.
• Position: S Corporations

The Eighth Circuit, affirming the Tax Court, has held that S shareholders could not increase their tax bases in the corporation for corporate debt when the debt did not run directly to them (Est. of Alton Bean, 10/1/01).

Alton Bean and his son, Gary, operated a trucking company, Alton Bean Trucking Company (Company), and treated the business as a partnership. The Beans formed an S corporation, Alton Bean Trucking, Inc. (S Corporation), and continued running both businesses. On Dec. 31, 1992, Company sold all of its assets to S Corporation, which assumed all of Company's liabilities. S Corporation experienced net operating losses in 1990 and 1991. The shareholders claimed a pro-rata share of the losses on their individual tax returns. The IRS disallowed the losses because they exceeded the shareholders' respective bases in S Corporation and assessed tax deficiencies.

Following the sale of its assets to S Corporation, Company's only asset on its financial statement was a receivable from S Corporation for services and parts provided to S Corporation. The shareholders argued that they were entitled to increase their bases for the amount of the receivable, because they were never paid for the services and parts. The court disagreed. Any transaction that made up the balance of the receivable was between Company and S Corporation; thus, the balance in the receivable could not increase the shareholders' bases. The court also rejected the shareholders' argument that their pledging of personal property for a third-party loan to S Corporation created basis.

The disallowance of S shareholder basis for indirect debt and for third-party debt secured by personal property is well-established law. However, there are two interesting aspects of the Bean decision. First, the court cited Hitchens, 103 TC 711 (1994), in which the court disallowed basis for a loan from a partnership to an S corporation. The court stated:

The taxpayers cannot...