In Maloof v. Commissioner, the Sixth Circuit on Friday affirmed the Tax Court’s holding (T.C. Memo. 2005-75) that a shareholder did not increase his basis in his wholly-owned S Corporations by being a co-obligor and guarantor on a $4 million bank loan because he didn’t make an economic outlay:

In filing a series of individual tax returns in the 1990s, William Maloof claimed significant deductions for losses incurred by S corporations that he owned. Under § 1366(d)(1), Maloof’s deductions from these losses could not exceed his basis in the stock or debt of the corporations. Recognizing that the losses greatly exceeded his initial investment in the corporations, Maloof claimed that a $4 million bank loan to the corporations in 1993, on which Maloof was a co-obligor and guarantor, permissibly increased his basis in debt of the S corporation to the shareholder (or possibly stock of the S corporation owned by the shareholder). The relevant statutes and case law, however, permit an increase in basis in debt (or stock) only when the taxpayer makes an economic outlay to the corporation, and Maloof’s status as a coobligor on the loan established just the possibility, not the reality, of an economic outlay for the corporation. We therefore affirm the decision of the Tax Court upholding over $3 million in tax deficiencies issued by the Internal Revenue Service against Maloof.