In Uncategorized on 04/11/2017 at 00:34

In the world of Sub S Corp stock basis-building, taking on corporate debt builds a stockholder’s basis. But the stockholder must prove s/he is truly the primary obligor, to whom the lender looked at inception of the debt.

Of course, actually paying the lender, even when a mere guarantor, elevates the stockholder’s basis.

Briefly, you have to pay the buy-in, or be truly the first one on the hook.

I just discussed this in my blogpost “The Check’s the Thing – Part Deux,” 2/28/17, but since it was a paltry Sum. Op. small-claimer, it didn’t get the citation it deserves in Rupert E. Phillips and Sandra K. Phillips, 2017 T. C. Memo. 61, filed 4/10/17.

And the reason my blogpost is delayed is the overwhelming hospitality of my brother and his wife. Many thanks again; what a great family I got.

Anyway, Judge Lauber is dealing with Sandy. Rupe was a bit player, an employee in the developer Sub S of which Sandy owned 50%. But Sandy’s castlebuilding enterprise turned into sand castles in the Great Meltdown of 2006-2007.

Sandy and fellow stockholders personally guaranteed loans, but most of those were collateralized by land and buildings, that initially looked good. Sandy couldn’t get any bank witnesses to swear they were really lending to her.

The banks foreclosed, but the properties brought way less than the debt, so they sued Sandy. The banks got judgments, but Sandy never paid.

Sandy nevertheless got a law firm (apparently a respected one, as the penalties gets scrubbed) to opine she could build basis on that basis. She did, took losses, got audited, and claimed her guarantees were proper basis builders.

We all know that actual economic outlay is “coin of the realm” when it comes to building basis in Sub S stock. The phrase is erroneous, of course. Put simply and more accurately, “no pain, no gain.”

The leading case for personal guarantees without actual payment, blessed by 11 Cir., to which Sandy is Golsenized, involves the stockholder pledging personal assets, borrowing in stockholder’s own name, with a novation at lender’s request resulting in the note being recast in the name of the Sub S but guaranteed by stockholder because Sub S was an undercapitalized start-up. And stockholder’s personal assets remain pledged for the indebtedness.

That’s not the case here.

“There is no evidence that [Sub S]’s lenders had a prior relationship with petitioners or that petitioners previously had been obligors on these loans. Petitioners did not pledge any of their personal assets as collateral for the loans; all the collateral (consisting primarily of real estate) was supplied by the [Sub S’ wholly-owned special purpose entities] or their subsidiaries. [Sub S] was a well- established company with a good reputation, and petitioners conceded that the loans when made were ‘clearly supported by the collateral that was pledged.’ Most importantly perhaps, petitioners produced no testimony or other evidence from any of the lending banks that any bank ‘look[ed] to the shareholder as the primary obligor’ on any loan. It is hard to see how a taxpayer could establish a bank’s intentions or expectations on this point without producing testimony from someone at the bank.” 2017 T. C. Memo. 61, at p.18 (Citation omitted).

And Sandy’s argument that the deficiency judgments obtained by the lenders injured her credit so as to create and economic outlay is about as useful as those judgments.

“A court’s entry of a deficiency judgment against a guarantor many years later, after the corporation has defaulted and the corporation’s collateral has proven insufficient, is simply not relevant in determining whether the lender, when initially extending credit, looked to the shareholder as the primary source of repayment.” 2017 T. C. Memo. 61, at p. 20.

Besides, there were co-guarantors with Sandy. Sandy’s allocation of deficiencies among the co-guarantors makes assumptions not sustained by the record. It’s not the Court’s job to make favorable guesses where the record is empty.

But Judge Lauber gets to the point thus: “Had Mrs. Phillips made an actual payment toward these judgments, of course, the basis increase to which she would be entitled would be obvious. The speculative and conjectural nature of the computational exercise in which petitioners must engage absent any payment underscores the wisdom of the rule that no basis increase is allowed without an actual economic outlay.” 2017 T. C. Memo. 61, at pp. 23-24.

Sandy, to repeat myself, the check’s the thing.


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