In Maguire v. Commissioner (TC Memo 2012-160), the taxpayer held stock in two S corporations. One corporation, Auto Acceptance (AA), operated a car dealership and the other corporation, CNAC, purchased the retail installment notes generated by AA. CNAC was profitable and AA lost money. While shareholders of an S corporation can deduct the corporation’s losses on their individual income tax returns, their deductions are limited to the amount of tax basis the shareholders have in their stock.
In the Maguire case, the taxpayer needed more basis in his AA shares to deduct the losses and, to increase his AA basis, he caused CNAC to distribute some of the auto finance receivables that it held. He then contributed these receivables to the capital of AA and claimed an increased tax basis in his AA shares. The IRS opposed this attempt to augment basis, arguing that the contribution of the receivables did not represent any new economic outlay on the part of the shareholder.
The court disagreed, finding that the receivables were real debts of AA owed to CNAC. The contribution of these receivables to AA had economic consequences because when a creditor contributes an obligation to the debtor, it can no longer collect the debt. The court also pointed out that while the taxpayer increased his basis in his AA shares, the distribution of the receivables by CNAC reduced the basis of his CNAC shares by an equivalent amount. The end result was that the shareholder was able to move basis from shares in which he did not need it to shares in which he did.