The Ninth Circuit Court of Appeals recently affirmed a Tax Court decision, holding that shareholders of an S corporation could not increase their tax basis for loans held by a sister S corporation. In the unpublished opinion, see Dana D. Messina et ux. et al. v. Commissioner; No. 18-70186, the Court held that S corporation shareholders could not use a substance over form argument to circumvent regulatory provisions, which provide that S corporation shareholders can only claim tax basis for loans that run directly between the shareholder and the S corporation. See our prior alert on the Tax Court’s decision.
This decision is another in a long line of rulings where courts and the IRS have denied shareholder attempts to claim losses against debt held by related parties. The Eleventh Circuit recently reached the same conclusion in a similar case.
The string of cases demonstrates that the courts appear to agree with the IRS position on this issue, and any deviation from the regulatory requirements will likely prevent a shareholder from claiming tax basis for a loan and recognizing losses against that basis.
