Losses and deductions for an S corporation stockholder are limited to the basis of the stockholders stock together with the adjusted basis of any indebtedness of the S corporation to the stockholder. As a basic axiom, a loan directly from a financial institution to the S corporation does not increase the stockholders basis; but the loan from the bank to the stockholder and then to the S corporation does increase basis. In Bolding v. Commissioner, 97-2 USTC 89, 209 (5th Cir. 1997), the Fifth Circuit Court of Appeals determined that a loan was, in effect, from the financial institution to the taxpayer and then to the S corporation because the parties stipulated that all of the loan proceeds were deposited in the corporate account. Because the bank loan was to the taxpayer alone and he caused all of the proceeds to be deposited into the corporate account as a loan by him to the corporation, the taxpayer was entitled to his full deductions.
Bolding established a cattle ranch operation, through Three Forks Land & Cattle Company ("Three Forks") an S corporation, which was wholly owned by the taxpayer, who was its president. The taxpayer had initially lent approximately $500,000 to Three Forks. Although these loans were recorded in Three Forks books and records as loans from a shareholder, no promissory notes for these loans were prepared or executed. The taxpayer and his accountant realized that Three Forks would not be able to repay Bolding the money he had lent it and additional capital was necessary. As a result, the indebtedness for this money previously advanced as a loan to Three Forks was contributed to the capital of the corporation but Bolding still needed additional working capital. He contacted a bank and explained that he wanted a loan to fund his cattle operation. He sought a line of credit from the bank in the amount of $250,000. The bank approved the $250,000 line of credit and prepared a promissory note, which Bolding signed, naming "Dennis E. Bolding d/b/a Three Forks Land & Cattle Co." as the borrower. The bank also required the filing of a security agreement and a UCC-1 financing statement. None of the loan documents prepared by the bank were prepared for the corporation, Three Forks, nor were any signed by anyone on behalf of the corporation. The funds were disbursed directly from the bank to the Three Forks account. The line of credit was rolled over into later years, after its initial maturity, but ultimately went into default with an outstanding balance. The bank sued Bolding for repayment on the outstanding balance of the loan; no action was taken against Three Forks. Three Forks reported an ordinary loss for 1990 of $93,769. Bolding deducted that amount on his 1990 income tax return as his share of the S corporations loss.
The commissioner disagreed with taxpayers deductions, and issued a statutory notice of deficiency. The commissioner disallowed the entire net loss claim for 1990 on the grounds that taxpayer had insufficient basis in Three Forks stock to support such an allowance. The commissioner maintained that Three Forks was the true borrower from the bank with respect to the funds advanced under the $250,000 line of credit so that, consequently, there was no loan by taxpayer to the corporation with respect to that line of credit. Accordingly, the commissioner concluded that taxpayers asis in the corporation did not increase as a result of the funds advanced by the bank on the $250,000 loan and that Bolding was not entitled to deduct any of the corporations net operating loss on his individual return for 1990.
The Tax Court entered a memorandum opinion holding that taxpayer was not entitled to deduct the corporations net operating loss. The Tax Court determined as a fact that Bolding, rather than Three Forks, was the true borrower from the bank with respect to the funds disbursed under the $250,000 line of credit. The court, however, ultimately agreed with the commissioner that taxpayer did not have sufficient basis in Three Forks stock or debt to entitle him to deduct any of the corporations net operating loss.
On appeal, the Fifth Circuit was faced with the issue: "In other words, we must determine whether the $250,000 line of credit was a loan from the Bank to Three Forks or whether it was a loan to Taxpayer, who in turn furnished it to Three Forks as either a loan or a capital contribution." Id. At 89.211.
Generally a taxpayer is bound by the form of the transaction chosen and a taxpayer may not in hindsight recast the transaction as one that they might have made in order to obtain tax advantages. In Bolding, the "form" of the $250,000 line of credit was consistent as a loan from the bank to the taxpayer, not to the corporation. "The promissory note was signed by Taxpayer, not in his representative capacity on behalf of Three Forks, but rather as an individual borrower. Taxpayer did not sign the note, or for that matter any other document associated with the $250,000 line of credit as President of Three Forks or in some other representative capacity. Case omitted. Moreover, instead of including Three Forks identification number on the note -- which the Bank would have done had Three Forks been the borrower -- the note contained only Taxpayers personal social security number. Finally, Taxpayer signed both the security agreement and UCC-1 financing statement in his individual capacity. Clearly, all of the loan documents, in form, establish that Taxpayer was the true borrower of the line of credit." Id. at 89,211-89,212.
The Fifth Circuit concluded that the bank intended and understood that Bolding, not the corporation, was the borrower of the loan. The bank looked solely to Bolding for repayment. The bank never asked for any financial information respecting Three Forks. The corporations 1990 corporate year-end balance sheet reflected the loan as one from Bolding to the corporation, and Three Forks 1990 corporate tax return showed the line of credit as a loan from Bolding, appearing as loans from stockholders. Because the bank loan was to Bolding alone and he caused all of the proceeds of the loan to be deposited into Three Forks corporate account as a loan by him to Three Forks, he was entitled to his full deductions.