Amounts borrowed from fellow S shareholder not at-risk for basis purposes.

An S shareholder can deduct losses, but only to the extent of basis. Generally, stock basis includes amounts that a shareholder has loaned to an S corporation for which he is "at-risk." Thus, if a shareholder has loaned money to an S corporation and he is "at-risk," he can use the loan as basis for deducting losses passed through from the corporation.

In Van Wyk, 113 TC No. 29 (1999), the Tax Court ruled that a loan from a fellow shareholder, subsequently reloaned to the S corporation, did not create basis, because the shareholder was not at-risk.

The Van Wyks and the Roordas each owned 50% of the stock of an S corporation in the farming business. The Van Wyks borrowed money from the Roordas and were personally liable for repaying the loan. They then loaned the proceeds to the S corporation (some of the money paid off old debts and the balance was a new loan). The Van Wyks claimed they were at-risk on the loan and, thus, could use the loan's basis to allow them to deduct their share of the S corporation's loss for the year.

The IRS disallowed the loss on the Van Wyks' personal return, claiming that they were not at-risk; the Tax Court agreed with the Service. Sec. 465(b)(3)(A) states that amounts borrowed from a person who has an interest in the activity are not treated as at-risk, even if the borrower is personally liable for repayment. In addition, Sec. 465(b)(3)03) states, "in the case of amounts borrowed by a corporation from a shareholder, subparagraph (A) shall not apply to an interest as a shareholder." Thus, for purposes of the at-risk rules and to claim losses, the party from whom the funds are borrowed is critical.

The Van Wyks argued that they met the Sec. 465(b)(3)(B)(i) interest-as-creditor test, because they were personally liable; thus, the fact that they were shareholders should be disregarded.

S stock basis is increased by loans that shareholders make to an S corporation. However, Prop. Regs. Sec. 1.465-9(f) considers whether the loam come from a shareholder's personal funds. The Van Wyks argued that the proposed regulations were over 19 years old and were still in proposed form. They also argued that neither the statute nor legislative history contains any mention of "personal funds" Thus, they argued the proposed regulations should carry little weight. The court stated that although the regulations are in proposed form, they are to be used as guidelines. The court also noted that the taxpayers "embraced proposed regulations as support for their argument, yet argue that they do not apply when the proposed regulations present contrary authority."

The Tax Court ruled that Sec. 465(b)(3)03)(ii) allows at-risk treatment only for corporate borrowers, not for individual borrowers. The court also concluded the at-risk rules do not allow individual shareholders to claim "at-risk basis" simply because they loan money to their corporation. The court also cited the committee reports to the law that first introduced Sec. 465(b)(3)(B)(ii). In addition, the court noted that, before this provision, the at-risk rules had been revised to eliminate their application to S corporations.

In conclusion, monies borrowed from a person with an interest in an activity are not treated as "at-risk" even though the individual is personally liable for repayment.

FROM JON E. DAVIS, SIOUX FALLS, SD