Estate of Leavitt v. Commissioner

VAFLA Corporation, an S corporation, obtained a $300,000 bank loan in its own name. Several shareholders of VAFLA—including Anthony and Marjorie Cuzzocrea (plaintiffs) and Daniel Leavitt (plaintiff) (collectively, the shareholders)—agreed to be held jointly and severally liable for the corporation’s indebtedness to the bank. All payments on the loan were made by VAFLA, with no direct contribution from the shareholders. Because VAFLA operated at a loss, the shareholders claimed the losses as deductions against their gross income, as is customary in an S corporation. The Commissioner of Internal Revenue (the commissioner) (defendant) disallowed deductions above a $10,000 basis, reflecting each shareholder’s original investment in VAFLA. The shareholders challenged this determination in the United States Tax Court, arguing that the loan was actually a capital contribution from the shareholders to VAFLA, entitling each shareholder to add a pro rata share of the $300,000 to his or her basis. The court ruled in favor of the commissioner, holding that the transaction was a loan from the bank to VAFLA in both form and substance. The shareholders appealed. The United States Court of Appeals for the Fourth Circuit granted certiorari. By this point in the proceedings, Leavitt had died, and his interests were represented by his estate.