In a recent opinion by the tax court, TC Summary Opinion 2017-9, the Tax Court held that a Shareholder’s guarantee of a loan to his S Corp., did not give him basis in the entity; and as a result, he could not deduct his distributive share of the entity’s losses.
Generally, deductions and losses of an S corporation are passed through to shareholders and claimed on their own returns. Under IRC 1366, a shareholder may deduct his pro rata share of these passed-through items only to the extent of the sum of his adjusted basis in the S corporation stock, determined by taking into account the increases in basis for his share of the S corporation income during the year and the decreases in basis for nondividend distributions for the year, plus his adjusted basis in any indebtedness of the S corporation to him. There are three shareholder loss limitations: (1) stock and debt basis limitation; (2) at risk limitations; and (3) passive activity losses limitations; each limitation must be met, and in the order presented, before a shareholder is allowed to claim a flow-through loss.
The fact that a shareholder receives a K-1 reflecting a loss does not mean that the shareholder is automatically entitled to claim the loss. Treasury Regulation 1.1366-2 indicates that for transactions on or after July 23, 2014, an S corporation shareholder who merely acts as a guarantor or in a similar capacity has not created basis of indebtedness, unless the shareholder actually makes a payment, and then only to the extent of such payment. Additionally, the courts have generally held that merely guaranteeing an S corporation’s debt was not enough to generate a basis.
In the instant case, although the Shareholder made all loan payments following the liquidation of the company, facts did not show whether he made the payments from his personal funds or merely signed checks drawn on the account of the Tax Court held the Shareholder could not establish that the lender looked to him primarily, rather than to the S Corp., for repayment; and also could not establish that he made an economic expenditure with respect to the loan.