MEMORANDUM OPINION
WELLS, Judge: Respondent determined deficiencies in Federal income taxes for petitioners Fleming G. Brooks and Sherry H. Brooks in the case at docket No. 8981-03 as follows 1:
Addition to tax | ||
Year | Deficiency | Sec. 6662(a) |
1999 | $207,552 | $997.60 |
2000 | 190,105 | 1,027.60 |
Respondent determined deficiencies in Federal income taxes and additions to tax for the Estate of Fleming S. Brooks and Merle R. Brooks in the case at docket No. 8983-03 as follows:
Year | Deficiency |
1999 | $ 157,207 |
2000 | 163,910 |
After concessions, the issue to be decided is whether the advances of open account debt by petitioners to their closely held S corporation in 1999 and 2000 provided petitioners with basis to offset repayments of open account debt2005 Tax Ct. Memo LEXIS 204">*205 made by the company in 1999 and 2000, prior to each respective advance. 2
Background
The parties submitted the instant case fully stipulated, without trial, pursuant to
Petitioners Fleming G. Brooks and Sherry H. Brooks are husband and wife. At the time of filing the petition, they resided in Samson, Alabama. During the years in issue, Fleming S. Brooks and Merle R. Brooks were husband and wife. Fleming S. Brooks died on March 30, 2001. At the time of filing the petition, Merle R. Brooks resided in Samson, Alabama. Fleming G. Brooks and Fleming S. Brooks (Messrs. Brooks) and their respective spouses were calendar year taxpayers.
At all relevant times, Fleming S. Brooks owned 51 percent of the stock of Brooks AG Company, Inc., (the2005 Tax Ct. Memo LEXIS 204">*206 company), and Fleming G. Brooks owned 49 percent. The company was an S corporation with a calendar year tax year, and Messrs. Brooks each had a zero basis in their stock in the company during all relevant times.
Before and during the years in issue, Messrs. Brooks advanced money to the company on open account on three occasions. The open account transactions and related computations of Messrs. Brooks are described in detail in the Appendix to this opinion. The first such advance occurred during 1997, when Messrs. Brooks each advanced $ 500,000 to the company on open account (referred to collectively as the $ 1 million advance). The second advance occurred on December 31, 1999, when Messrs. Brooks each advanced $ 800,000 to the company on open account (referred to collectively as the $ 1.6 million advance). The third advance occurred on December 29, 2000, when Messrs. Brooks each advanced $ 1.1 million to the company on open account (referred to collectively as the $ 2.2 million advance). On January 5, 1999, the company made a $ 500,000 repayment to each of Messrs. Brooks (referred to collectively as the $ 1 million repayment). On January 3, 2000, the company made a $ 800,000 repayment2005 Tax Ct. Memo LEXIS 204">*207 to each of Messrs. Brooks (referred to collectively as the $ 1.6 million repayment).
As of the close of 1998, the outstanding balance of open account debt owed by the company to Messrs. Brooks equaled the amount advanced to the company during 1997; i.e., $ 1 million. However, pro rata company losses during 1997 and 1998 had reduced Messrs. Brooks's basis in the open account debt to zero.
When Messrs. Brooks made the $ 1.6 million advance at the close of 1999, it was an amount sufficient, in Messrs. Brooks's view, to (1) provide a basis offset for the $ 1 million repayment and (2) allow for the recognition by Messrs. Brooks of their pro rata share of company losses incurred during 1999. 3
2005 Tax Ct. Memo LEXIS 204">*208 When Messrs. Brooks made the $ 2.2 million advance at the close of 2000, it was an amount sufficient, in Messrs. Brooks's view, to (1) provide a basis offset for the $ 1.6 million repayment and (2) allow for the recognition by Messrs. Brooks of their pro rata share of company losses during 2000. 4
Respondent concedes that Messrs. Brooks's advances to the company and the company's repayments of the advances constituted open account debt and does not contend that any of the advances constituted separate indebtedness. Other than the advances described2005 Tax Ct. Memo LEXIS 204">*209 above, Messrs. Brooks advanced no money to the company from 1997 to December 31, 2000.
Discussion
We must decide whether the $ 1.6 million advance provided sufficient basis to offset the $ 1 million repayment on January 5, 1999, in addition to allowing recognition of Messrs. Brooks's pro rata share of company losses for 1999, and whether the $ 2.2 million advance provided sufficient basis to offset the $ 1.6 million repayment on January 3, 2000, in addition to allowing recognition of Messrs. Brooks's pro rata share of losses for 2000.
A lender recognizes income to the extent that repayment of the debt exceeds the lender's basis in the debt. See
A shareholder of an S corporation must take into account the shareholder's pro rata share of the S corporation's items of income, loss, deduction, and credit. 5
2005 Tax Ct. Memo LEXIS 204">*211 Although a shareholder may not reduce stock basis below zero, a shareholder with a zero stock basis may recognize further losses to the extent of the shareholder's debt basis, including the shareholder's advances to the S corporation. See
2005 Tax Ct. Memo LEXIS 204">*213 In the instant case, the record reveals that the amount of the company's losses in 1997, 1998, 1999, and 2000, exceeded the amount of the company's income in each respective tax year. Consequently, pursuant to
For the purpose of determining taxable income upon an S corporation's repayment of shareholder advances, a separate transaction involving an advance and repayment of indebtedness is generally treated separately. See
Petitioners contend that the basis of a shareholder's open account debt is properly determined at the close of the S corporation's tax year2005 Tax Ct. Memo LEXIS 204">*215 by first netting advances and repayments of open account debt during the tax year and then making any necessary debt basis adjustments. Respondent relies on
We believe that respondent's reliance in the instant case on
The real question to be decided is whether each advance to the
corporation by the shareholders and its corresponding repayment
constitute a separate and complete transaction or whether the
indebtedness should be2005 Tax Ct. Memo LEXIS 204">*216 considered as an "open account" whose
fluctuations are to be measured for tax purposes at the end of
each taxable year. ** * The Tax Court properly determined that
"the 1966 loans and the [1967] repayments thereof constituted a
completed transaction, and the loans occurring later in 1967
were separate and apart from such transaction." * * *
[Id.; citation omitted.]
Based on the Tax Court's finding in Cornelius that the loans were separate transactions and not open account indebtedness, the taxpayers were required to recognize as taxable income the amount of the repayment in excess of the taxpayers' basis in the advance at the time of repayment, without2005 Tax Ct. Memo LEXIS 204">*217 regard to the basis of a subsequent advance in the year of repayment.
2005 Tax Ct. Memo LEXIS 204">*218 Based on the parties' stipulations that the advances were open account debt and respondent's failure to contend that any advance and repayment composed a separate transaction, we hold that the basis of the open account indebtedness is properly computed by netting at the close of the year advances of open account debt during the year and repayments of open account debt during the year. Cf.
We have considered all contentions that the parties have raised. 12 To the extent not addressed herein, those contentions are without merit or unnecessary to reach.
2005 Tax Ct. Memo LEXIS 204">*219 To reflect the foregoing and concessions by the parties,
Decisions will be entered under
Appendix
With respect to the 1999 tax year, respondent's position results in (1) a debt basis of $ 358,707 for petitioners in docket No. 8981-03 at the close of 1999, reflecting a reduction of basis in the $ 800,000 advance only by an allowable loss of $ 441,293, and (2) a debt basis of $ 386,056 for petitioners in docket No. 8983-03 at the close of 1999, reflecting a reduction of basis in the $ 800,000 advance only by an allowable loss of $ 413,944 for petitioners' 1999 tax year.
With respect to the 2000 tax year, respondent's position results in (1) a debt basis of $ 718,762 for petitioners in docket No. 8981-03 at the close of 2000, reflecting a reduction of basis in the $ 1,100,000 advance only by an allowable loss of $ 381,238, and (2) a debt basis of $ 703,202 for petitioners in docket No. 8981-03 at the close of 2000, reflecting a reduction of basis in the $ 1,100,000 advance only by an allowable loss of $ 396,798.
With respect to the 1999 tax year, petitioners contend that the basis of each $ 800,0002005 Tax Ct. Memo LEXIS 204">*220 advance was first reduced by the $ 500,000 repayments on January 5, 1999, and then further reduced by $ 300,000 of pro rata company losses, resulting in a zero debt basis at the close of 1999.
With respect to the 2000 tax year, petitioners contend that the basis of each $ 1,100,000 advance was first reduced by the $ 800,000 repayments on January 3, 2000, and then further reduced by $ 300,000 of pro rata company losses, resulting in a zero debt basis at the close of 2000.
With respect to the 1999 tax year, respondent determined that (1) petitioners in docket No. 8981-03 had a taxable gain of $ 500,000 related to the repayment of January 5, 1999 ($ 500,000 repayment less zero debt basis), and (2) petitioners in docket No. 8983-03 had a taxable gain of $ 500,000 related to the repayment of January 5, 1999 ($ 500,000 repayment less zero debt basis). 13
2005 Tax Ct. Memo LEXIS 204">*221 With respect to the 2000 tax year, respondent determined that petitioners in docket No. 8981-03 had a taxable gain of $ 441,293 related to the repayment of January 3, 2000 ($ 800,000 repayment less $ 358,707 debt basis), and that petitioners in docket No. 8983-03 had a taxable gain of $ 413,944 related to the repayment of January 3, 2000 ($ 800,000 repayment less $ 386,056 debt basis). 14
With respect to the 1999 tax year, petitioners contend that the $ 800,000 basis of each advance offset the $ 500,000 repayments on January 5, 1999, and also allowed for the recognition of $ 300,000 of the pro rata share of the company's losses.
With respect to the 2000 tax year, petitioners contend that the $ 1,100,000 basis of each advance offset the $ 800,000 repayments on January 3, 2000, and also permitted each petitioner to recognize $ 300,000 of the pro rata share of the company's losses.
1. These cases are consolidated for purposes of briefing and opinion (hereafter collectively the instant case).↩
2. All section references are to the Internal Revenue Code, as amended, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩
3. Petitioners contend that Messrs. Brooks's bases in the open account debts were also reduced by offsetting the $ 1 million repayment. As discussed below, respondent contends that the repayment of open account debt may not be offset by the basis of an open account advance subsequent to the repayment. However, respondent does not dispute that the $ 1 million advance provided Messrs. Brooks with sufficient bases to recognize their respective pro rata losses for 1999.↩
4. Petitioners contend that Messrs. Brooks's bases in the open account debts were also reduced by offsetting the $ 1,600,000 repayment. As discussed below, respondent contends that the repayment of open account debt may not be offset by the basis of an open account advance subsequent to the repayment. However, respondent does not dispute that the $ 1,600,000 advance provided Messrs. Brooks with sufficient bases to recognize their respective pro rata losses for 2000.↩
5.
(1) Cannot exceed shareholder's basis in stock and debt. -- The aggregate amount of losses and deductions taken into account by a shareholder under subsection (a) for any taxable year shall not exceed the sum of --
(A) the adjusted basis of the shareholder's stock in the S
corporation (determined with regard to paragraphs (1) and (2)(A)
of
(B) the shareholder's adjusted basis of any indebtedness of the
S corporation to the shareholder (determined without regard to
any adjustment under paragraph (2) of
taxable year).↩
6.
(1) General rule. If, after making the adjustments required by
7.
8. Respondent concedes that the Dec. 31, 1999, open account advance provided sufficient debt basis for petitioners to recognize the losses claimed in 1999 and that the Dec. 29, 2000, advance provided sufficient debt basis for petitioners to recognize the losses claimed in 2000.↩
9.
10. Pursuant to
11. In
12. We note that the parties have argued extensively regarding the scope of
13. Respondent attached to the docket No. 8981-03 statutory notice of deficiency the following calculation of taxable gain on debt repayment:
Computation of Taxable Debt Repayment | |
1997 loan from shareholder 500,000 | 500,000 |
Less: 1997 loss applied to basis | (195,042) |
Less: 1998 loss applied to the basis | (319,875) |
1997 loan basis 0 | 0 |
1999 loan repayment | 500,000 |
Taxable gain on loan repayment | 500,000 |
Respondent attached to the docket No. 8983-03 statutory notice of deficiency the following calculation of taxable gain on debt repayment:
Computation of Taxable Debt Repayment | |
1997 loan from shareholder 500,000 | 500,000 |
Less: 1997 loss applied to basis | (203,002) |
Less: 1998 loss applied to the basis | (296,998) |
1997 loan basis 0 | 0 |
1999 loan repayment | 500,000 |
Taxable gain on loan repayment | 500,000 |
14. Respondent attached to the docket No. 8981-03 statutory notice of deficiency the following calculation of taxable gain on debt repayment:
Computation of Taxable Debt Repayment | |
"1999" loan from shareholder | 800,000 |
Less: 1999 loss used against loan | |
Basis of 1999 loan | 358,707 |
Repayment of loan made in 2000 | |
Taxable gain on loan repayment | 441,293 |
Respondent attached to the docket No. 8983-03 statutory notice of deficiency the following calculation of taxable gain on debt repayment:
Computation of Taxable Debt Repayment | |
"1999" loan from shareholder | 800,000 |
Less: 1999 loss used against loan | |
Basis of 1999 loan | 386,056 |
Repayment of loan made in 2000 | |
Taxable gain on loan repayment | 413,944 |