When looking at reported decisions, I'm always reluctant to criticize arguments attorneys make in tough cases. For one thing, courts have been known to misunderstand or misconstrue perfectly reasonable, even if incorrect, arguments in order to fortify their own decisions and the reported opinion may actually make a plausible case appear to look preposterous. For another, the facts that are presented at trial may not be the facts upon which counsel based the decision to undertake representation. Every attorney who has been in practice for even a few years has horror stories about cases that looked great at the beginning, but which crumbled as "new" facts came to light. There are, however, a small class of cases that raise the question: "Why did they bother?" Maloof v. Commissioner decided today by the U.S. Tax Court is such a case.
In Maloof, the taxpayer was a sole shareholder of an S corporation that suffered a long succession of tax losses. Because his ability to use the losses of the corporation were limited to his basis in the corporation's stock, the taxpayer attempted to increase his basis in the stock by including in basis $4 Million in bank loans made to the corporation. Apparently, except for a pledge of his stock in the corporation, the taxpayer was not at risk with respect to the loans.
The opinion reads like the Children's Goldenbook of S Corporation Taxation with the Court walking through fairly basis principles of S corporation taxation. The taxpayer's positions were so adverse to established law that I'm surprised that there was no mention of possible sanctions for taking a frivolous position. (My favorite ludicrous position taken by the taxpayer is that he was a resident of Florida and thus the precedent of the 11th Circuit applied to the case. Why was he a resident of Florida: He lived with his mother, not his wife, who lives in Ohio. Note to Counsel: Your client's name is "Maloof" not "Oedipus.")
The case is instructive on one point: LLCs classified as partnerships or as disregarded entities have benefits over S corporations. Were the company an LLC classified as a partnership or a disregarded entity, the taxpayer would have obtained the benefits he sought. And, he wouldn't have had to run home to momma.