1977 U.S. Tax Ct. LEXIS 170">*170 Amounts were paid into the capital of a subch. S corporation on behalf of petitioners, evidenced by nonrecourse notes and secured by their stock in the corporation. Petitioners deducted losses incurred by the corporation as stockholders, not to exceed their basis in the stock, including such advances. Ultimately, petitioners surrendered their stock in discharge of the notes.
67 T.C. 656">*656 SUPPLEMENTAL OPINION
In our opinion filed April 22, 1975 (
On appeal, the U.S. Court of Appeals for the Third Circuit remanded the case in order that the Tax Court might determine whether the amounts contributed to the capital of the corporation by or on behalf of the petitioners constituted loans from R. H. Jamison, Jr., or whether such amounts should be treated as gifts by him to the petitioners.
In the trial of the case before the Tax Court, petitioners did not contend that the amounts purportedly "loaned" to them by Mr. Jamison should be treated as gifts. On the contrary, petitioners were given an opportunity to present the testimony of R. H. Jamison, Jr., for the purpose of raising the issue and declined to do so. In petitioners' brief, the Tax Court was requested to find the following:
(1) Grant was a West Virginia business corporation, electing Internal Revenue Code subchapter S treatment, and petitioners were Grant shareholders consenting to such election (Stip. pars. 11 and 12).
(2) Since August 1, 1964, petitioners were, and even now continue to be, shareholders of Grant (Stip. pars. 30 and 33).
(3) From July 28, 1964, to December 20, 1965, petitioners borrowed $ 500,000 from Jamison and forwith paid the total thereof into Grant as capital to be used for corporate purposes (Stip. pars. 26 and 27).
(4) As security for Jamison's loans to petitioners, demand, promissory, nonrecourse notes were signed by petitioners and their Grant stock was 67 T.C. 656">*658 assigned by petitioners to Jamison by separate stock powers, as collateral to their1977 U.S. Tax Ct. LEXIS 170">*174 notes (Stip. pars. 26, 27, 31).
Again, in the same brief under the title "Did R. H. Jamison, Jr. Make Gifts To Petitioners?", petitioners make the following statement:
Although it is Jamison's immediate problem, petitioners know of no action or event, delivery, notice, or otherwise, usually required in the making of a completed gift, that Jamison has taken or participated in involving Grant stock or the petitioners' notes payable to him, that would constitute a gift, reportable to respondent.
On the basis of the record, the Court is unable to find that there was a gift of $ 500,000 to the petitioners by R. H. Jamison, Jr. He caused the Grant County Coal Corp. to be organized and transferred certain leases to the corporation, with the expectation that the venture would be successful. He caused the stock to be issued in the names of the petitioners and his business associates without consideration, at which time it must be assumed that the stock had no value. In order to provide working capital for the corporation, Mr. Jamison from time to time issued checks totaling $ 500,000 in the names of the respective shareholders in order that this amount might be contributed by them to the1977 U.S. Tax Ct. LEXIS 170">*175 corporation. Mr. Jamison then took back nonrecourse notes from each of the shareholders secured by their stock.
If the venture had met with success, it must be presumed that Mr. Jamison intended to recoup the amount of his advances from the petitioners. In fact, Mr. Jamison in turn borrowed the sum of $ 500,000 from the Mellon National Bank & Trust Co., further evidencing an intent on his part that the petitioners would ultimately be able to repay the $ 500,000 which he had advanced to them; and Mr. Jamison would in turn repay his loan to the bank.
Mr. Jamison's intent to recover his loan of $ 500,000 from the petitioners is further evidenced by the fact that he did not report the amounts loaned to them as gifts for purposes of the internal revenue laws.
In the absence of any proof to the contrary, the transaction speaks for itself. It was Mr. Jamison's intent to make a nonrecourse loan to the petitioners and not a "gift." As an experienced coal operator, Mr. Jamison obviously felt that he would be able to make some money for them from the 67 T.C. 656">*659 operations of the Grant County Coal Corp. and get his money back.
This Court found that the petitioners, and not Mr. Jamison, were1977 U.S. Tax Ct. LEXIS 170">*176 the real shareholders of Grant County Coal Corp. As such, petitioners made a valid election to be taxed under subchapter S of the Code (sec. 1372). Pursuant to such election, petitioners were chargeable with their pro rata share of the net taxable income and operating losses of the corporation (secs. 1373-1374). With respect to the losses allowed, however,
(2) Limitation. -- A shareholder's portion of the net operating loss of an electing small business corporation for any taxable year shall not exceed the sum of -- (A) the adjusted basis (determined without regard to any adjustment under (B) the adjusted basis (determined without regard to any adjustment under
The losses deductible by petitioners were thus limited to the adjusted basis of their stock of the corporation. At the outset, such basis was a nominal amount or "zero."
In order to provide working capital for the corporation, Mr. Jamison gave the petitioners checks from time to time, as needed, totaling $ 500,000, which were endorsed over by them as contributions to the capital of the corporation. Petitioners executed a series of nonrecourse notes with the stock as collateral to evidence this indebtedness. Except for the contributions to capital obtained in this manner, petitioners would not have been entitled to deduct the losses of the corporation in the first instance. The respondent's disallowance of such deductions would have been sustained by the Court.
In reliance on the rule enunciated by
At the time that these "loans" were contributed to the corporation, it cannot be said that the value of petitioners' stock which was pledged to secure the loans equaled or exceeded the amount of the indebtedness. In fact, the contributions were made to enable the corporation to continue in business notwithstanding recurring losses.
The term "adjusted basis" is defined by the statute. Neither the statute nor the
When it became apparent that the corporation faced bankruptcy, Mr. Jamison took the necessary steps to reacquire the stock in accordance with the terms of the notes. These steps amounted to a "foreclosure." Such a foreclosure would constitute a sale or exchange of the surrendered stock.
1977 U.S. Tax Ct. LEXIS 170">*180 In our opinion, the value of the stock was immaterial. Petitioners had received a cash equivalent in the amount of the notes, whether they were personally liable on such notes 67 T.C. 656">*661 or not.
Finally, the Court of Appeals suggested a discussion of petitioners' alternative reliance on the so-called purchase-money exception to the cancellation-of-indebtedness doctrine. 3 Suffice to say, the facts in this case do not present a situation where the parties got together and agreed upon a reduction in the price of property sold by one to the other. The satisfaction of the notes came about strictly in accordance with the terms of the original loans. Mr. 1977 U.S. Tax Ct. LEXIS 170">*181 Jamison exercised his right to foreclose.
Although not directed to do so, the Court has also reconsidered whether Robert K. Conrad, petitioner in docket No. 5893-72, has sustained his burden with respect to proof of error by the respondent in assessing the penalty under section 6653(a). In sustaining the penalty, the Court took cognizance of the fact that Mr. Conrad had been a tax practitioner for many years. He drew up the documents pursuant to which Mr. Jamison reacquired the stock by foreclosure. At another point, Mr. Conrad claimed that the petitioners were, in1977 U.S. Tax Ct. LEXIS 170">*182 fact, stockholders throughout the calendar year 1967 and right up to the trial. Apparently, Mr. Conrad adopted this position to justify his failure to include in his return for the taxable year 1967 the recapture of the investment tax credit under section 47. At the same time, he prepared a return for Mr. Jamison for the calendar year 1967 in which Mr. Jamison claimed the deduction of the net operating loss of Grant County Coal Corp., for the taxable year 1967, as its sole stockholder. On the whole, the Court concluded that the actions by Mr. Conrad 67 T.C. 656">*662 exhibited the intentional lack of regard for the law and regulations upon which the statute imposes the penalty.
Accordingly, having reconsidered our opinion in this matter, we find no reason to change our views and, therefore, reaffirm that opinion.
Sterrett,
1. Cases of the following petitioners are consolidated herewith: John R. Jamison and Suzon G. Jamison, docket No. 5885-72; Philip D. Rodgers and Elizabeth C. Rodgers, docket No. 5888-72; Philip R. Jamison and Helen L. S. Jamison, docket No. 5889-72; James L. Tenley and Betty J. Tenley, docket No. 5892-72; and Robert K. Conrad and Jane H. Conrad, docket No. 5893-72.↩
2. This result has also been suggested by a number of commentators. For discussion of this result, see Ginsburg, "The Leaky Tax Shelter,"
3. It should be noted that petitioners cited in support of this contention,
