Estate of Leavitt v. Commissioner

90 T.C. No. 16, 90 T.C. 206, 1988 U.S. Tax Ct. LEXIS 19

• Court: United States Tax Court
• Decided: February 10, 1988
• Docket: Docket Nos. 32041-84, 36453-84, 36454-84, 36455-84
• Status: Published

Opinions

OPINION

NIMS, Judge:

Respondent determined deficiencies in petitioners’ Federal income tax as follows:

Docket No. Tax year ended-Deficiency

32041-84 Dec. 31, 1979 $4,767.77

Dec. 31, 1980 1,577.06

36453-84 Dec. 31, 1979 3,031.29

Dec. 31, 1980 16,472.46

Dec. 31, 1981 13,919.88

36454-84 June 30, 1980 901.00

June 30, 1981 1,041.00

June 30, 1982 1,252.00

36455-84 Dec. 31, 1979 1,320.98

Dec. 31, 1980 1,495.88

Dec. 31, 1981 2,298.86

These cases were consolidated for trial, briefing, and opinion pursuant to Rule 141(a).² After concessions and stipulations,³ the only issue for decision is whether a shareholder’s guarantee of the debt of an electing small business corporation under subchapter S of the Internal Revenue Code increases the shareholder’s basis in his stock in the corporation.

All the facts have been stipulated. The stipulations of fact and attached exhibits are incorporated herein by this reference.

At the time the petitions in these cases were filed, Charles D. Fox III, Anthony D. Cuzzocrea, and Marjorie F. Cuzzocrea resided in Roanoke, Virginia.⁴ Daniel and Evelyn Leavitt, whose estates are petitioners in docket No. 32041-84, filed a joint Federal income tax return for the taxable year 1979.⁵ Anthony D. Cuzzocrea and Marjorie F. Cuzzocrea filed joint Federal income tax returns for the taxable years 1979, 1980, and 1981.

VAFLA Corp. (hereinafter referred to as the corporation), was an electing small business corporation under subchapter S during the years in issue and was incorporated in February 1979, to acquire and operate the Six-Gun Territory Amusement Park near Tampa, Florida. The initial issue of the corporation’s capital stock took place in March 1979, and consisted of 100,000 shares. Daniel Leavitt and Anthony D. Cuzzocrea each paid $10,000 cash for their shares on or before September 30, 1979.

The first taxable year of the corporation consisted of 7 months and ended on September 30, 1979. As of September 30, 1979, the corporation had suffered a net operating loss of $265,566.47 and had a retained earnings deficit of $345,370.20. During its second taxable year ending September 30, 1980, the corporation suffered a net operating loss of $482,181.22 and had a retained earnings deficit of $1,093,383.56. During its third taxable year ending September 30, 1981, the corporation suffered a net operating loss of $475,175.70 and had a retained earnings deficit of $1,908,680.22.

From August 2, 1979, through August 27, 1979, Anthony D. Cuzzocrea and Daniel Leavitt, as well as other shareholders, signed guarantee agreements whereby each agreed to be jointly and severally Hable for all indebtedness of the corporation to the Bank of Virginia. All the guarantees to the Bank of Virginia were unhmited except the guarantee of Anthony D. Cuzzocrea which was Mmited to $300,000.

The corporation borrowed $300,000 from the Bank of Virginia for which it issued a promissory note to the bank dated September 12, 1979. The purpose of the loan was to fund VAFLA’s existing and anticipated operating deficits.

At the time the loan was made, the corporation’s HabiHties exceeded its assets, and the corporation had so Httle available cash that it could not meet its cash-flow requirements. VirtuaUy all of the corporation’s assets were encumbered as coUateral for a purchase money indebtedness of approximately $1 milHon to National Service Industries, Inc. In processing the loan, the Bank of Virginia was provided a statement of income for the corporation for its first 3 months of operation during which the corporation experienced a loss of $142,410.16, resulting in a negative net worth of $82,410.16 as of May 31, 1979.

Seven of the corporation’s shareholders agreed to guarantee the $300,000 loan personaUy. According to the financial statements submitted to the bank, these shareholders had an aggregate net worth of $3,407,286 and immediate Hquidity (cash and securities) of $382,542. The loan was approved only because of the financial strength of the guarantors.

The Bank of Virginia loan was consistently shown on the corporation’s financial statements and tax returns for its fiscal years ending 1979, 1980, and 1981, as a loan from shareholders. However, during those years, the corporation made the following principal payments to the Bank of Virginia:

Dec. 26, 1979 .$10,000

July 15, 1980 . 10,000

Jan. 6, 1981. 10,000

All interest payments were also made by the corporation. None of the payments by the corporation on the principal or the interest of the loan were reported by the corporation or petitioners as constructive dividends.

Daniel and Evelyn M. Leavitt deducted a loss of $13,808 attributable to the corporation on their 1979 joint Federal income tax return. Respondent disallowed $3,808 of this deduction. Anthony D. and Marjorie F. Cuzzocrea deducted losses of $13,808, $29,921, and $22,746 attributable to the corporation on their 1979, 1980, and 1981 joint Federal income tax returns, respectively. Respondent disallowed all of these deductions in excess of $10,000.

Respondent takes the position that shareholders Daniel Leavitt and Anthony D. Cuzzocrea may not deduct losses attributable to the corporation in excess of their initial basis in their shares of the corporation. Petitioners maintain that their guarantees of the $300,000 loan to the corporation from the Bank of Virginia increased their basis in their stock sufficiently to allow deductions for their proportionate shares of losses attributable to the corporation during the years in issue.

Former section 1374,⁶ as in effect during the years in issue, permitted a shareholder in a subchapter S corporation to deduct his portion of the corporation’s net operating loss from his gross income. Former section 1374(c) limited the amount of the deduction to the sum of (1) the adjusted basis of the shareholder’s stock in the corporation and (2) the adjusted basis of any indebtedness of the corporation to the shareholder.

The corporation sustained losses for the taxable years 1979, 1980, and 1981. Before the guarantee transaction, petitioners Daniel Leavitt and Anthony D. Cuzzocrea each had an adjusted basis in their stock in the corporation of $10,000. We must determine whether petitioners’ guarantee of the $300,000 loan from the Bank of Virginia to the corporation increased the basis in petitioners’ stock in the corporation.

It is well settled that:

the fact that shareholders may be primarily liable on indebtedness of a corporation to a third party does not mean that this indebtedness is “indebtedness of the corporation to the shareholder” within the meaning of section 1374(c)(2)(B). No form of indirect borrowing, be it guaranty, surety, accommodation, comaking or otherwise, gives rise to indebtedness from the corporation to the shareholders until and unless the shareholders pay part or all of the obligation. * * * [Raynor v. Commissioner, 50 T.C. 762, 770-771 (1968).]

See also Putnam v. Commissioner, 352 U.S. 82 (1956); Underwood v. Commissioner, 535 F.2d 309 (5th Cir. 1976), affg. 63 T.C. 468 (1975); Perry v. Commissioner, 47 T.C. 159, affd. 392 F.2d 458 (8th Cir. 1968); Wheat v. United States, 353 F. Supp. 720 (S.D. Tex., 1973); Neal v. United States, 313 F. Supp. 393 (C.D. Cal. 1970).

In the instant case, petitioners have never been called upon to pay any of the login that they guaranteed. Accordingly, the guarantees that petitioners executed do not increase any indebtedness of the corporation to them.

Nevertheless, petitioners ask us to view the guarantee transactions as constructive loans from the banks to petitioners and, in turn, contributions of those same funds by petitioners to the capital of the corporation. In other words, petitioners contend that their guarantees of the $300,000 loan from the Bank of Virginia to the corporation should increase their basis in the stock of the corporation. We disagree.

Under former section 1374(c)(2) corporate debts to third parties guaranteed by the shareholder, whether collateral-ized or not, do not lead to an increase in the shareholder’s basis in his subchapter S corporation stock. To increase the basis in the stock of a subchapter S corporation, there must be an economic outlay or a realization of income on the part of the shareholder. Brown v. Commissioner, 706 F.2d 755 (6th Cir. 1983), affg. T.C. Memo. 1981-608; Calcutt v. Commissioner, 84 T.C. 716, 720 (1985).

The term “basis,” for purposes of section 1374(c), is defined in section 1012.⁷ Borg v. Commissioner, 50 T.C. 257, 263 (1968). Section 1012 provides the general rule that the “basis of property shall be the cost of such property.” Section 1.1012-l(a), Income Tax Regs., defines “cost” to mean the “amount paid” for property “in cash or other property.” Because petitioners’ guarantees in this case do not constitute cash or other property, they cannot be included in the basis of petitioners’ stock in the corporation.

In Borg v. Commissioner, supra, an electing small business corporation owed one of its shareholders unpaid salary for his performance of services as evidenced by notes from the corporation to the shareholder. The shareholder did not report any part of the unpaid salary as income in his returns. The shareholder in Borg argued that the notes for the unpaid salary increased his basis in the indebtedness of the corporation to him. We held that because the shareholder had incurred no cost in connection with the notes, he had no basis in the notes and therefore there was no addition to the adjusted basis of the indebtedness of the corporation to the shareholder. We explained:

cost for the purposes of the Code ordinarily means cost to the taxpayer. Detroit Edison Co. v. Commissioner, 319 U.S. 98 (1943). Where a taxpayer has not previously reported, recognized, or even realized income, it cannot be said that he has a basis for a note evidencing his right to receive such income at some time in the future. That petitioner Joe E. Borg performed valuable services for Borg Steel is undeniable; however, the performance of services, involving neither the realization of taxable income nor a capital outlay, is not the kind of cost that would be shown in a cash receipts and disbursements system of income accounting. See, e.g., Pounds v. United States, 372 F.2d 342, 351-352 (C.A. 5, 1967); Alsop v. Commissioner, 290 F.2d 726 (C.A. 2, 1961), affirming on other grounds 34 T.C. 606 (1960); Ernest W. Brown, Inc., 28 T.C. 682 (1957), affirmed per curiam 258 F.2d 829 (C.A. 2, 1958). Since the services performed by petitioner Joe E. Borg had no cost within the meaning of section 1012, his notes for unpaid salary had a basis of zero and, therefore, added nothing to the adjusted basis for indebtedness for the purpose of computing the section 1374(c)(2) limitation on net operating loss deductions. [Borg v. Commissioner, 50 T.C. at 263; emphasis in original.]

In this case, petitioners’ guarantees did not require any capital outlay on their part during the years in issue. Without capital outlay or a realization of income, as required by Borg, petitioners cannot increase their adjusted basis in their stock in the corporation. Nor can it of course be said that the guarantees in question were corporate debt obligations to petitioners which acquired a basis resulting from any capital outlays by petitioners. Petitioners ask, however, that we ignore the form of the transaction, i.e., a loan from the Bank of Virginia to the corporation that was guaranteed by its shareholders, and find that the bank actually loaned the money to the shareholder-guarantors who then advanced the proceeds of the loan as a contribution to the capital of the corporation. We decline to adopt petitioners’ view of the transaction.

The Bank of Virginia loaned the money to the corporation and not to petitioners. The proceeds of the loan were to be used in the operation of the corporation’s business. Petitioners submitted no evidence that they were free to dispose of the proceeds of the loan as they wished. Nor were the payments on the loan reported as constructive dividends on the corporation’s Federal income tax returns or on petitioners’ Federal income tax returns during the years in issue. Accordingly, we find that the transaction was in fact a loan by the bank to the corporation guaranteed by the shareholders.

Nevertheless, petitioners ask that we apply traditional debt-equity principles⁸ in determining the nature of the transaction in this case. Petitioners maintain that because the corporation was insolvent at the time the loan was made and because the bank would not have advanced the funds to the corporation without the shareholders’ guarantees, the loan was in fact a loan from the bank to the shareholders who then advanced the proceeds of the loan as a contribution to the capital of the corporation. We decline to adopt traditional debt-equity principles in this case.

Petitioners’ reliance on Blum v. Commissioner, 59 T.C. 436 (1972), is misplaced. In Blum the taxpayer, a shareholder in an electing small business corporation under subchapter S, also asked us to apply traditional debt-equity principles and treat his guarantee of a loan from a bank to the corporation as an indirect capital contribution. We declined to decide the issue as to the applicability of debt-equity principles because the taxpayer had failed his burden of proving that the bank in substance had loaned the funds to the taxpayer and not to the corporation. Blum v. Commissioner, 59 T.C. at 439 n. 4.

Petitioners’ reliance on In re Breit, 460 F. Supp. 873 (E.D. Va. 1978), is also misplaced. The facts in Breit were similar to the facts in Blum. The taxpayers in Breit raised the same argument as was raised in Blum that their guarantees of loans from a bank to their subchapter S corporation were actually loans from the bank to the shareholders and, in turn, contributions by the shareholders to the capital of the corporation. The court held in Breit, as in Blum, that the taxpayer-shareholders had failed their burden of proving that the loans that they had guaranteed were advanced to them rather than to the corporation. The court also considered and rejected various other variations on this theme, e.g., that the subchapter S corporation was the shareholder’s alter ego, also intended to show that the bank loans were actually made to the shareholder.

In Selfe v. United States, 778 F.2d 769 (11th Cir. 1985), the 11th Circuit applied a debt-equity analysis and held that a shareholder’s guarantee of a loan made to a subchapter S corporation may be treated for tax purposes as an equity investment in the corporation where the lender looks to the shareholder as the primary obligor. We respectfully disagree with the 11th Circuit and hold that a shareholder’s guarantee of a loan to a subchapter S corporation may not be treated as an equity investment in the corporation absent an economic outlay by the shareholder.

The Selfe opinion was based primarily on Plantation Patterns, Inc. v. Commissioner, 462 F.2d 712 (5th Cir. 1972), affg. T.C. Memo. 1970-182, in which the Fifth Circuit affirmed as not clearly erroneous a finding by this Court that a transaction structured as a loan by an independent third party to a corporation, and guaranteed by a shareholder, was in substance a loan to the shareholder followed by his contribution of the loan proceeds to the corporation, and that as a result the corporation’s payments of principal and interest on the debt constituted constructive dividends to the shareholder.

However, the corporation in Plantation Patterns was a subchapter C corporation. We decline to apply the debt-equity analysis used in Plantation Patterns to the guarantee of a loan to a subchapter S corporation. Congress has promulgated a set of rules designed to limit the amount of deductions allowable to a shareholder of a subchapter S corporation to the amount he has actually invested in the corporation and the amounts of income from the corporation included in the shareholder’s gross income. See former secs. 1374(c) and 1376.⁹ The report of the Committee on Finance of the Senate underscores Congress’ purpose as follows:

The amount of the net operating loss apportioned to any shareholder pursuant to the above rule is limited under section 1374(c)(2) to the adjusted basis of the shareholder’s investment in the corporation; that is, to the adjusted basis of the stock in the corporation owned by the shareholder and the adjusted basis of any indebtedness of the corporation to the shareholder. * * * [S. Rept. 1983, 85th Cong., 2d Sess. (1958), 1958-3 C.B. 1141. Emphasis added.]

As we construed this language in Perry v. Commissioner, 54 T.C. 1293, 1296 (1970), the use of the word “investment” reveals an intent, on the part of the committees, to limit the applicability of section 1374(c)(2) to the actual economic outlay of the shareholder in question. See also Pike v. Commissioner, 78 T.C. 822, 839-840 (1982), affd. without published opinion 732 F.2d 164 (9th Cir. 1984). To allow petitioners to increase the basis of their stock without a capital outlay or a realization of income would provide them a means of avoiding these limitations. See also Brown v. Commissioner, 706 F.2d at 756 (absent an economic outlay requirement for obtaining an increase in basis, subchapter S shareholders could readily skirt the limitation embodied in section 1374(c) and thereby erect a tax shelter that Congress never intended to create).

In Selfe, the court also relied on In re Lane, 742 F.2d 1311 (11th Cir. 1984), in which the 11th Circuit applied a debt-equity analysis and held that funds advanced to a subchapter S corporation by a shareholder and payments made by the shareholder as guarantor of corporate obligations to institutional lenders were capital contributions rather than loans from the shareholder to the corporation. In Lane, the shareholder had actually paid the amounts he had guaranteed and, therefore, the amounts he paid could be considered a contribution to capital. In this case, petitioners have not paid any of the loans they guaranteed and, therefore, have contributed nothing to the capital of the corporation.

Petitioners’ reliance on section 1.385-9, Proposed Income Tax Regs., is also misplaced. The proposed regulation was withdrawn in 1983. T.D. 7920, 1983-2 C.B. 69. Proposed regulations are only preliminary proposals; they are not binding on respondent or on the Court. Garvey, Inc. v. United States, 1 Cl. Ct. 108 (1983), affd. 726 F.2d 1569 (Fed. Cir. 1984). Moreover, section 1.385-9, Proposed Income Tax Regs., was drafted in connection with section 385, which is a part of subchapter C of the Internal Revenue Code. Because we hold that the debt-equity analysis does not apply to guaranteed loans to subchapter S corporations for which the shareholder has incurred no cost, the proposed regulation is not relevant in this case.

To reflect the foregoing,

Decisions will be entered under Rule 155.

Reviewed by the Court.

Sterrett, Chabot, Parker, Whitaker, Kórner, Shields, Hamblen, Cohen, Clapp, Jacobs, Gerber, Wright, Parr, Wells, and Ruwe, JJ., agree with the majority opinion. SWIFT and Whalen, JJ., concur in the result only.

2 Unless otherwise indicated, all Rule references are to the Tax Court Rules of Practice and Procedure. All section references are to the Internal Revenue Code of 1954 as in effect during the years in issue.

3 The parties stipulated that this Court’s resolution of the issues presented in Estate of Anthony Gacek, Deceased, Charles D. Fox, III, Executor, et al. v. Commissioner of Internal Revenue, docket Nos. 17890-81, 17891-81, 17892-81, 17893-81, 10059-82, 10060-82, 10061-82, 10062-82, and 458-84, will control several of the issues in these consolidated cases. Since the time of the parties’ agreement, those issues have been decided. See Estate of Gacek v. Commissioner, T.C. Memo. 1987-349. After further concessions by the parties, no issues remain with respect to docket Nos. 36454-84 and 36455-84 or the 1980 year in docket No. 32041-84.

4 At the time the petitions in docket Nos. 36454-84 and 36455-84 were filed, Verla J. Wirth resided in Salem, Virginia, and Valley Pathology Associates, Inc., and Dominion Trust Co. had their principal offices in Roanoke, Virginia. However, no issues remain for consideration in docket Nos. 36454-84 and 36455-84. See note 3 supra,

5 Evelyn M. Leavitt, on behalf of herself and her deceased husband, filed a joint Federal income tax return for 1980. However, no issues relating to this return are before the Court. See note 3 supra.

6 Former sec. 1374 as in effect during the years in issue provided:

SEC. 1374. CORPORATION NET OPERATING LOSS ALLOWED TO SHAREHOLDERS.

(a) General Rule. — A net operating loss of an electing small business corporation for any taxable year shall be allowed as a deduction from gross income of the shareholders of such corporation in the manner and to the extent set forth in this section.

(b) Allowance of Deduction. — Each person who is a shareholder of an electing small business corporation at any time during a taxable year of the corporation in which it has a net operating loss shall be allowed as a deduction from gross income, for his taxable year in which or with which the taxable year of the corporation ends (or for the final taxable year of a shareholder who dies before the end of the corporation’s taxable year), an amount equal to his portion of the corporation’s net operating loss (as determined under subsection (c)). The deduction allowed by this subsection shall, for purposes of this chapter, be considered as a deduction attributable to a trade or business carried on by the shareholder.

(c) Determination of Shareholder's Portion.—

(1) In general. — For purposes of this section, a shareholder’s portion of the net operating loss of an electing small business corporation is his pro rata share of the corporation’s net operating loss (computed as provided in section 172(c), except that the deductions provided in part VIII (except section 248) of subchapter B shall not be allowed) for his taxable year in which or with which the taxable year of the corporation ends. For purposes of this paragraph, a shareholder’s pro rata share of the corporation’s net operating loss is the sum of the portions of the corporation’s daily net operating loss attributable on a pro rata basis to the shares held by him on each day of the taxable year. For purposes of the preceding sentence, the corporation’s daily net operating loss is the corporation’s net operating loss divided by the number of days in the taxable year.

(2) Limitation. — A shareholder’s portion of the net operating loss of an electing small business corporation for any taxable year shall not exceed the sum of—

(A) the adjusted basis (determined without regard to any adjustment under section 1376 for the taxable year) of the shareholder’s stock in the electing small business corporation, determined as of the close of the taxable year of the corporation (or, in respect of stock sold or otherwise disposed of during such taxable year, as of the day before the day of such sale or other disposition), and

(B) the adjusted basis (determined without regard to any adjustment under section 1376 for the taxable year) of any indebtedness of the corporation to the shareholder, determined as of the close of the taxable year of the corporation (or, if the shareholder is not a shareholder as of the close of such taxable year, as of the close of the last day in such taxable year on which the shareholder was a shareholder in the corporation).

In 1982, Congress revised the rules pertaining to subch. S corporations in the Subchapter S Revision Act of 1982, Pub. L. 97-354, 96 Stat. 1669. The revisions in the 1982 Act do not apply in this case, however, because they apply only to taxable years beginning after Dec. 31, 1982. Sec. 6(a), Subchapter S Revision Act of 1982, Pub. L..97-354, 96 Stat. 1669, 1697 (1982). The taxable years in this case are 1979, 1980, and 1981.

We note, however, that the limitations provided in former sec. 1374(c)(2) were reenacted by sec. 2 of the Subchapter S Revision Act of 1982 in sec. 1366(d)(1). Sec. 1366(d)(1) is currently in effect.

7 Sec. 1012 provides:

The basis of property shall be the cost of such property, except as otherwise provided in this subchapter and subchapters C (relating to corporate distributions and adjustments), K (relating to partners and partnerships), and P (relating to capital gains and losses). The cost of real property shall not include any amount in respect of real property taxes which are treated under section 164(d) as imposed on the taxpayer.

8 The debt-equity analysis usually is applied to guaránteed debts in cases involving subch. C corporations in which respondent argues that advances made in the form of a guaranteed debt are in substance capital contributions. See, e.g., John Kelly Co. v. Commissioner, 326 U.S. 521 (1946); Casco Bank & Trust Co. v. United States, 544 F.2d 528 (1st Cir. 1976); Plantation Patterns, Inc. v. Commissioner, 462 F.2d 712 (5th Cir. 1972), affg. T.C. Memo. 1970-182; Murphy Logging Co. v. United States, 378 F.2d 222 (9th Cir. 1967); Smyers v. Commissioner, 57 T.C. 189 (1971); Santa Anita Consolidated, Inc. v. Commissioner, 50 T.C. 536 (1968); Kavich v. United States, 507 F. Supp. 1339 (D. Neb. 1981). The courts generally consider the following factors in determining whether a debt transaction should be regarded as a contribution to equity:

“(1) The names given to the certificates evidencing the indebtedness; (2) the presence or absence of a maturity date; (3) the source of the payments; (4) the right to enforce the payment of principal and interest; (5) participation in management; (6) a status equal to or inferior to that of regular corporate creditors; (7) the intent of the parties; (8) ‘thin’ or adequate capitalization; (9) identity of interest between creditor and stockholder; (10) payment of interest only out of ‘dividend’ money; (11) the ability of the corporation to obtain loans from outside lending institutions. [Plantation Patterns, Inc. v. Commissioner, 462 F.2d at 718-719, quoting Montclair, Inc. v. Commissioner, 318 F.2d 38, 40 (5th Cir. 1972). Fn. ref. omitted.]”

O.H. Kruse Grain & Milling v. Commissioner, 279 F.2d 123, 125-126 (9th Cir. 1960), affg. a Memorandum Opinion of this Court.

In addition, courts take into consideration factors such as the extent to which the advance was used to acquire capital assets and the failure of the debtor to repay on the due date or to seek a postponement. In re Lane, 742 F.2d 1311, 1315 (11th Cir. 1984); Estate of Mixon v. United States, 464 F.2d 394, 402 (5th Cir. 1972); Fin Hay Realty Co. v. United States, 398 F.2d 694, 696 (3d Cir. 1968).

See also sec. 385, which provides as follows:

SEC. 385. TREATMENT OF CERTAIN INTERESTS IN CORPORATIONS AS STOCK OR INDEBTEDNESS.

(a) Authority To Prescribe Regulations. — The Secretary is authorized to prescribe such regulations as may be necessary or appropriate to determine whether an interest in a corporation is to be treated for purposes of this title as stock or indebtedness.

(b) Factors. — The regulations prescribed under this section shall set forth factors which are to be taken into account in determining with respect to a particular factual situation whether a debtor-creditor relationship exists or a corporation-shareholder relationship exists. The factors so set forth in the regulations may include among other factors:

(1) whether there is a written unconditional promise to pay on demand or on a specified date a sum certain in money in return for an adequate consideration in money or money’s worth, and to pay a fixed rate of interest,

(2) whether there is subordination to or preference over any indebtedness of the corporation,

(3) the ratio of debt to equity of the corporation,

(4) whether there is convertibility into the stock of the corporation, and

(5) the relationship between holdings of stock in the corporation and holdings of the interest in question.

Congress enacted sec. 385 in the Tax Reform Act of 1969, Pub. L. 91-172, 83 Stat. 487, 613. Proposed regulations under this section had been issued but were withdrawn in 1983. T.D. 7920, 1983-2 C.B. 69. At the present time there are no regulations implementing the provisions of sec. 385.

In making the debt-equity determination, the Court must decide each case on its own facts, and no one standard is controlling. Plantation Patterns, Inc. v. Commissioner, supra; Santa Anita Consolidated, Inc. v. Commissioner, supra

9 Former sec. 1376, as in effect during the years in issue, provided:

SEC. 1376. ADJUSTMENTS TO BASIS OF STOCK OF, AND INDEBTEDNESS OWING, SHAREHOLDERS.

(a) Increase in Basis of Stock for Amounts Treated as Dividends. — The basis of a shareholder’s stock in an electing small business corporation shall be increased by the amount required to be included in the gross income of such shareholder under section 1373(b), but only to the extent to which such amount is included in his gross income in his return, increased or decreased by any adjustment of such amount in any redetermination of the shareholder’s tax liability.

(b) Reduction in Basis of Stock and Indebtedness for Shareholder’s Portion of Corporation Net Operating Loss —

(1) Reduction in Basis of Stock. — The basis of a shareholder’s stock in an electing small business corporation shall be reduced (but not below zero) by an amount equal to the amount of his portion of the corporation’s net operating loss for any taxable year attributable to such stock (as determined under section 1374(c)).

(2) Reduction in basis of indebtedness. — The basis of any indebtedness of an electing small business corporation to a shareholder of such corporation shall be reduced (but not below zero) by an amount equal to the amount of the shareholder’s portion of the corporation’s net operating loss for any taxable year (as determined under section 1374(c)), but only to the extent that such amount exceeds the adjusted basis of the stock of such corporation held by the shareholder.

In 1982, Congress revised the rules pertaining to subch. S corporations in the Subchapter S Revision Act of 1982, Pub. L. 97-354, 96 Stat. 1669. The provisions of the revising act apply to the taxable years beginning after Dec. 31, 1982, and therefore do not apply in this case. See note 6 supra.