It’s the famous 11 (count ’em, 11) factor test, wherein most taxpayers want debt (to sustain interest deductions). But Estate of Thomas H. Fry, Deceased, Ruth M. Fry, Personal Representative, and Ruth M. Fry, T. C. Memo. 2024-8, filed 1/23 /24, want equity, and they get it.

Unusually, IRS wants debt, although IRS is usually fighting for equity.

Why the reversal?

Well, the late Tom (before he became the late Tom) had two Sub S Corps, one that collected garbage and the other that processed it. They worked together; worked from the same location with the same personnel, accountant, etc. But the processing Sub S lost its biggest contract, so Tom infused cash from the collector to the processor by having collector do bank-to-bank transfers to processor.

But when a white knight bought out the whole operation, Tom had a bunch accumulated losses (hi, Judge Holmes) from the processor that he wanted to deduct. IRS said he had insufficient basis in the processor stock, and Section 385, duty of consistency, and doctrine of election, prevent Tom from claiming that the infusions were capital contributions (building basis via deemed distributions from collector).

Judge Christian N. (“Speedy”) Weiler blows off Section 385, at least for Sub S Corps.

“We agree with petitioners’ primary position that section 385(c) does not apply to the facts herein as there was no formal issuance of any instrument evidencing the creation of an interest in stock or equity. The issuance of an interest in debt is typically contained in a promissory note and an equity interest is typically contained in a stock certificate. No such issuance of a promissory note or a stock certificate occurred here. Thus, on the basis of a plain reading of the statute, we hold section 385(c) inapplicable.” T. C. Memo. 2024-8, at p. 12. (Footnote omitted, but it says no court ever held Section 385 bound anybody to an initial characterization.).

The paperwork is nonexistent to prove debt.

Consistency and election go by the board, as Tom’s brilliant accountant shows he corrected the books before audit, and rebuts IRS’ computations of Tom’s basis in processor stock. But Judge Speedy Weiler, like all judges, won’t add, so the actual computation must abide the Rule 155 beancount, as must the impact of the deemed distributions to Tom that went to fund the processor.

A Taishoff “good job, first class,” goes to the late Tom’s (and Ruth’s) trusty attorneys, and accountant.

Note (off-topic): This post is late due to the opening of the New York City Ballet’s Winter season (75th year), with an all-Robbins program, featuring the music of L. (“Maestro”) Bernstein, F. Chopin, and G. Verdi. Of course, also included was “no’ bad jigging,” as they say in the Highlands. And a very touching speech by the winner of the 2024 Janice Levin Prize for promising member of the corps de ballet, Naomi Corti, a young woman from Luxembourg, from whom we’ll see a lot in years to come.

Sure beat writing about Tax Court.