Feb 02, 2017

IRS had no basis to disallow losses

After the audit of an S corporation for the 2009 tax year, the IRS disallowed some corporate deductions and further disallowed the $24 million corporate loss allocated to the shareholders asserting that the shareholders lacked adequate basis. The shareholders retained us to dispute the IRS determination.

The shareholders claimed that they had adequate basis in the S corporation because they each loaned funds to the S corporation and that the loans created basis even though they were back-to-back loans. This means that the shareholders were the sole owners of both an S corporation and an LLC. The loan scenario was the following—the LLC received a bank loan and then loaned the funds to the shareholders who loaned the funds to the S corporation. IRS regulations allow back-to-back loans to create shareholder basis. The shareholder also argued in the alternative that the losses are deductible because in 2011 all shareholder loans were contributed to the S corporation for equity. Thus, at a minimum the losses would be deductible in 2011 and could be carried back as net operating losses to 2009.

We protested the results of the audit for a hearing before the IRS Office of Appeals. However, while the case was pending, the three year statute of limitations for the 2011 tax year was about to expire. We counseled the shareholders to each file protective claims for refunds so that in the event it was finally determined that the shareholders had no basis in 2009, the shareholders would, nevertheless, be eligible to take the losses in 2011. Unfortunately, the IRS Office of Appeals affirmed the loss disallowance and we filed petitions to Tax Court.

After completing discovery, IRS counsel agreed that the shareholders had adequate basis and were permitted to deduct the losses in 2009. IRS counsel further agreed to allow the corporate deductions. Thus, a collective $8.2 million deficiency was removed resulting in no tax due and no penalties owed.

The message is that persistence is often critical when fighting the IRS.

This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.

Client alert authored by: David B. Shiner, Principal

This alert originally appeared in the February 2017 Shiner's Dollars with Sense newsletter.