Loan repayment to shareholder’s spouse wasn’t constructive distribution Beckley, 130 TC No. 18 (2008)
The Tax Court has ruled that payments made by a corporation to the wife of one of its shareholders represented repayment of money she advanced to a predecessor corporation. Despite the absence of a written loan agreement, the repayment wasn’t a constructive distribution to the shareholder.
Facts in brief. In ’88, Alan Beckley and Robert Ebert incorporated CT Inc., a software development company and each owned 50% of the company. CT often ran short of funds and in ’88 through ’99, it borrowed at least $106,834 from Alan’s wife, Virginia. The corporation used the borrowed funds to develop a working model of Web-based video conferencing software. CT had financial problems and was dissolved in ’98. In 2000, VDN, Inc., was incorporated to succeed to CT’s business and to continued to develop business products. Alan was a shareholder in VDN. The working model of the video conferencing software developed by CT was transferred to VDN in 2000, but the latter did not execute a written loan assumption agreement with regard to CT’s loan repayment obligation to Virginia. She did not make a claim against CT for repayment of the funds she lent to it, did not treat her loan to CT as a worthless loan, and did not claim an ownership interest in the working model.
In 2001, VDN paid Virginia $95,434. It treated $58,600 of that amount as interest which it reported on Form 1099INT and the balance as repayment of principal. Virginia reported the interest portion of the payment on her return as interest. In 2002, VDN paid Virginia $70,000. Virginia treated the $70,000 as repayment of principal. On its returns for 2001 and 2002, VDN deducted the payments to Virginia as nonemployee compensation.
In 2003 Alan Beckley and Robert Ebert were terminated by VDN, and it made no further payments to Virginia. When it audited the Beckleys’ returns for 2001 and 2002, IRS didn’t challenge their characterization of the amounts received from VDN, but asserted that one half of the amounts received by Virginia also were corporate distributions taxable as capital gain to Alan. IRS’s theory was that VDN’s payments to Virginia on her loan to CT were made without any legal obligation to do so and only on the basis of a personal moral obligation of Alan and Ebert to repay Virginia. Thus, it argued that VDN’s payments represented constructive corporation distributions.
Amounts represented loan repayment. The Tax Court ruled that the facts didn’t support IRS’s theory that VDN’s payments to Virginia were made to satisfy only personal moral obligations of Alan and of Ebert. Although VDN did not execute a written loan assumption agreement, it effectively purchased the working model from CT, assumed at least part of CT’s obligation to repay Virginia’s loan to CT, and thus, its payments to Virginia related to that original loan. Although there was no written agreement reflecting VDN’s obligation to repay Virginia, its conduct in actually making payments to Virginia, which related to her loan to CT and to CT’s transfer of the working model to VDN, established the loan repayment character of the payments. In addition, the Form 1099-INT that VDN mailed to Virginia and to IRS for 2001 reflected that $58,600 represented interest on a loan.