Decision will be entered under Rule 155.
P and L each own 50 percent of the stock in W, an S
corporation engaged in the business of farming. P and his wife
borrowed funds from L and his wife. On the same day, P
transferred to W funds equal in amount to the loan from L and
his wife. Part of the funds P transferred to W paid off
preexisting debts P owed to W, and the remainder represents a
new debt from W to P (the loan). R determined that P is not at
risk with respect to the loan to W and disallowed P's share of
W's losses.
1. HELD: Pursuant to
with respect to the loan. The at-risk treatment of amounts
borrowed by a taxpayer and contributed to an activity is
governed by
at risk with respect to the loan because
I.R.C., bars at-risk treatment with respect to amounts that are
borrowed from a person with a prohibited interest in the
activity, and L's equity interest is such an interest. Sec.
corporation from its shareholders, does not apply to except P
from
2. 1999 U.S. Tax Ct. LEXIS 57">*58 HELD, FURTHER, P is not liable for penalties under sec.
113 T.C. 440">*440 OPINION
WELLS, JUDGE: Respondent determined deficiencies in petitioners' income taxes of $ 60,371, $ 14,884, $ 6,875, and $ 20,173 for their 1988, 1991, 1992, and 1993 taxable years respectively, and additions to tax pursuant to
In the instant case, after concessions, we must decide the following issues: (1) Whether petitioner Larry Van Wyk is at risk with respect to a loan he made to an S corporation in which he owns 50 percent of the stock, where the source of 113 T.C. 440">*441 the funds constituting the loan is the other 50-percent shareholder and that shareholder's wife; and (2) whether petitioners are liable for substantial understatement penalties under
BACKGROUND
The 1999 U.S. Tax Ct. LEXIS 57">*59 parties submitted the instant case fully stipulated pursuant to Rule 122. The facts stipulated by the parties are incorporated herein by reference and are found as facts in the instant case. When they filed their petition, petitioners resided in Monroe, Iowa.
During the years in issue, petitioner Larry Van Wyk (petitioner) and his brother-in-law, Keith Roorda, each owned 50 percent of the stock of West View of Monroe, Iowa, Inc. (West View), an S corporation engaged in the business of farming.
On December 24, 1991, petitioners borrowed $ 700,000 from Keith Roorda and his wife, Linda Roorda. To evidence their debt to Keith and Linda Roorda (the Roordas), petitioners executed a promissory note bearing interest at 10.5 percent per annum. The note was unsecured. Also, on December 24, 1991, petitioners transferred $ 700,000 to West View. Of that amount, $ 253,583 retired debts petitioners owed to West View with the remaining $ 444,417 constituting indebtedness owed by West View to petitioners (the loan).
On their tax returns for 1988 through 1993, petitioners reported one-half of the profits and losses from West View. Respondent determined that petitioners' income should be increased in the 1999 U.S. Tax Ct. LEXIS 57">*60 amounts of $ 252,503, $ 438,811, $ 115,230, and $ 165,277 for the taxable years 1988, 1991, 1992, and 1993, respectively, on account of the disallowance of petitioners' deductions of West View's losses for those years. Additionally, respondent determined that, for 1993, petitioners' income should be increased by $ 93,239, on account of the disallowance of petitioners' deduction of West View's loss for the 1991 taxable year, which petitioners carried forward to 1993. Finally, respondent determined that petitioners are liable for a substantial understatement penalty pursuant to
113 T.C. 440">*442 DISCUSSION
We have been asked to resolve whether petitioner is at risk with respect to the loan. 21999 U.S. Tax Ct. LEXIS 57">*61 Petitioners argue that petitioner should be considered at risk with respect to the loan pursuant to
The relevant portions of
(a) Limitation to Amount at Risk. --
(1) In general. -- In the case of --
(A) an individual, and
(B) a C corporation with respect to which the
stock ownership requirement of paragraph (2) of
section 542(a) is met,
engaged in an activity to which this section applies, any
loss from such activity for the taxable year shall be
allowed only to the extent of the aggregate amount with
respect to which the taxpayer is at risk (within the
meaning of subsection (b)) for such activity at the close
of the taxable year.
* * * * * * *
(b) Amounts Considered at Risk. --
(1) In general. -- For purposes of this section, a
taxpayer shall be considered at risk for an activity with
respect 1999 U.S. Tax Ct. LEXIS 57">*62 to amounts including --
(A) the amount of money and the adjusted basis of
other property contributed by the taxpayer to the
activity, and
(B) amounts borrowed with respect to such
activity (as determined under paragraph (2)).
(2) Borrowed amounts. -- For purposes of this section,
a taxpayer shall be considered at risk with respect to
amounts borrowed for use in an activity to the extent that
he --
(A) is personally liable for the repayment of
such amounts, or
(B) has pledged property, other than property
used in such activity, as security for such borrowed
amount (to the extent of the net fair market value of
the taxpayer's interest in such property).
* * * * * * *
(3) Certain borrowed amounts excluded. --
(A) In general. -- Except to the extent provided
in regulations, for purposes of paragraph (1)(B),
amounts borrowed shall not be considered 113 T.C. 440">*443 to be at risk
with respect to an activity if such amounts are
borrowed from any person who has an interest in such
activity or from a related person to a person (other
1999 U.S. Tax Ct. LEXIS 57">*63 than the taxpayer) having such an interest.
(B) Exceptions. --
(i) Interest as creditor. -- Subparagraph
(A) shall not apply to an interest as a creditor
in the activity.
(ii) Interest as shareholder with respect to
amounts borrowed by corporation. -- In the case
of amounts borrowed by a corporation from a
shareholder, subparagraph (A) shall not apply to
an interest as a shareholder.
* * * * * * *
(c) Activities to Which Section Applies. --
(1) Types of activities. -- This section applies to
any taxpayer engaged in the activity of -- * * *
(B) farming (as defined in section 464(e)),
* * *
Petitioners' first argument is that petitioner should be considered at risk with respect to the loan pursuant to
A is the single shareholder in X, an electing small business
corporation engaged in an activity described in section
465(c)(1). 1999 U.S. Tax Ct. LEXIS 57">*64 A contributed $ 50,000 to X in exchange for its stock
under section 351. In addition, A borrowed $ 40,000 for which A
assumed personal liability. A then loaned the entire amount to X
for use in the activity. * * * At the close of the taxable year
(without reduction for any loss of X) A's amount at risk is
$ 90,000 ($ 50,000 plus $ 40,000). * * *
As we read the foregoing example, it does not contemplate a situation where the amounts A contributed to X are borrowed by A from a person who has an interest in X. The source of the contributed amounts is critical because it is
Petitioners additionally argue that
As to what is meant by "money * * * contributed by the taxpayer to the activity" within the meaning of
Petitioners acknowledge the proposed regulations regarding personal funds but note that they are over 19 years old and still in proposed form. Petitioners also note that the personal 1999 U.S. Tax Ct. LEXIS 57">*66 funds requirement is not mentioned in either the statute or the legislative history. Accordingly, petitioners claim that the proposed regulations carry little weight as to the personal funds requirement. We think it anomalous that petitioners embrace the proposed regulations as support for their argument, yet argue that the proposed regulations do not apply when they present contrary authority. Nonetheless, proposed regulations are given no greater weight than a position advanced by the Commissioner on brief. See, e.g.,
113 T.C. 440">*445 To read
Respondent also points to statements by the Staff of the Joint Committee on Taxation as an explanation of how Congress intended
The amounts borrowed by the taxpayer and then contributed to the
activity (or used to purchase property which is contributed to
the activity) are "amounts borrowed with respect to" the
activity (as referred to in
are subject to the rules of
amounts (or property) are also described in section
465(b)(1)(A). [Staff of the Joint Comm. on Taxation, General
Explanation of the Tax Reform Act of 1976, at 39 n.12 (J. Comm.
1999 U.S. Tax Ct. LEXIS 57">*68 Print 1976).]
The General Explanation is in accord with our own conclusion as to the operation of the statute. In short, petitioners fail to marshal any meaningful support for their argument under
Petitioners additionally contend that the loan should be considered at risk pursuant to
Van Wyk loaned funds to West View, thus fulfilling the first
clause of
amounts borrowed by a corporation from a shareholder . . .").
Because this requirement is met, Roorda's status as a
shareholder is disregarded and
apply. 113 T.C. 440">*446 Since Van Wyk was personally liable to repay the loan to
Roorda,
1999 U.S. Tax Ct. LEXIS 57">*69 has amounts "at risk" under
In essence, petitioners argue that
We agree with respondent that the proper interpretation is that
The House report accompanying the enactment of the Deficit Reduction Act of 1984 (DEFRA), Pub. L. 98-369, sec. 432(c), 98 Stat. 494, 814, the act which added
Borrowing from related parties
The bill provides that recourse borrowing from related parties
(including family members and entities controlled by the
taxpayer) may be considered at risk for purposes of the loss
limitation and investment tax credit at-risk rules. Except as
otherwise provided by regulations, recourse borrowing will be
considered not at risk when the related party has an interest
(other than as a creditor) in the activity or when the taxpayer
is otherwise protected against loss. The bill also specifies
that A CORPORATION MAY BE CONSIDERED AT RISK with respect to
amounts borrowed from its shareholders to finance participation
in an activity. [H. Rept. 98-432 (Part 2), at 1514-1515 (1984);
emphasis added. 61999 U.S. Tax Ct. LEXIS 57">*73 ]
The quoted passage indicates that a corporation may be at risk for amounts borrowed from its shareholders by reason of
Petitioners contend that if Congress intended the exception of
Additionally, we note that 2 years after
For the reasons stated above, we simply are not persuaded by petitioners' arguments or their interpretation of the statute. Accordingly, we hold that, because the source of the funds constituting the loan is not excepted by
The final issue is whether petitioners are liable for a penalty under
The
To reflect the foregoing,
Decision will be entered under Rule 155.
1. Unless otherwise noted, all section and Code references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩
2. The parties have stipulated the losses which petitioners will be entitled to deduct in accordance with our decision as to whether petitioner is at risk with respect the loan. Accordingly, other than the penalty issue discussed below, this is the only issue which we are called upon to decide. The parties also agree that the at-risk determination is to be made at the shareholder level and not at the S corporation level.
3. In
4. "Related person" includes a spouse. See
5. Put more technically, the following analysis was set forth in respondent's brief:
"Taxpayer" in * * * paragraph 465(b)(1) is the antecedent to
which "amounts borrowed by a corporation" found in subparagraph
465(b)(3)(B)(ii) refers. The clause "amounts borrowed by a
corporation" found in subparagraph 465(b)(3)(B)(ii) relates back
to the phrase "amounts borrowed" found in subparagraph
465(b)(3)(A). The phrase "amounts borrowed" found in
subparagraph 465(b)(3)(A) relates back to the phrase "amounts
borrowed" found in subparagraph 465(b)(1)(B). The phrase
"amounts borrowed" found in subparagraph 465(b)(1)(B) relates
back to the term "taxpayer" found in both * * * paragraph
465(b)(1) and paragraph 465(b)(2). This * * * [syntactical]
analysis reveals the clause "by a corporation" to be a term of
limitation to the more general "taxpayer" found in section
465(b)(2), * * * to which
Respondent's analysis comports with our own analysis above.↩
6. The Staff of Joint Committee on Taxation, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, at 736 (J. Comm. Print 1984), contains nearly identical language:
The Act further provides that, except to the extent provided in
regulations, recourse borrowing will not be considered at risk
where the lender has an interest (other than as a creditor) in
the activity or is related to a person (other than the taxpayer)
having such an interest. However, the Act specifies that a
corporation may be considered at risk with respect to amounts
borrowed from its shareholders to finance participation in an
activity.↩
7. Previously, with respect to S corporations, the at-risk limitations of