SCOTUS Reports

Tag: Personal Guarantees

  • Rock Bordelon and Torie Bordelon v. Commissioner of Internal Revenue, T.C. Memo. 2020-26: Personal Guarantees and At-Risk Rules in Tax Deduction Cases

    Rock Bordelon and Torie Bordelon v. Commissioner of Internal Revenue, T. C. Memo. 2020-26 (United States Tax Court, 2020)

    In a significant tax ruling, the U. S. Tax Court held that personal guarantees can establish sufficient at-risk amounts to allow deductions for losses from business activities. The decision affirmed that Rock Bordelon’s guarantees for loans to his business entities, Many LLC and Kilgore LLC, made him personally liable, thus enabling him to claim over $1. 5 million in previously disallowed losses. This ruling clarifies the application of the at-risk rules under I. R. C. § 465 and the impact of personal guarantees on a taxpayer’s basis in partnerships under I. R. C. § 704(d), offering guidance for taxpayers and tax professionals on the deductibility of business losses.

    Parties

    Rock Bordelon and Torie Bordelon, as petitioners, against the Commissioner of Internal Revenue, as respondent. The Bordelons were the taxpayers seeking redetermination of tax deficiencies determined by the Commissioner.

    Facts

    Rock Bordelon was engaged in the healthcare business, owning Allegiance Health Management, Inc. (AHM), a medical services company, and Allegiance Hospital of Many, LLC (Many LLC), which he formed to purchase and own a hospital in Louisiana. In 2008, Many LLC and AHM borrowed a $9. 9 million loan (Many Loan) from Union Bank, secured by the hospital and its equipment, with Bordelon executing a personal guarantee as required by the USDA. Many LLC was treated as a disregarded entity for federal tax purposes, with its income and expenses reported on Bordelon’s Schedule C. Bordelon also owned a 90% interest in Allegiance Specialty Hospital of Kilgore, LLC (Kilgore LLC), a partnership, which borrowed $550,000 in 2011 (Kilgore Loan) from Home Federal Bank, with Bordelon as the sole guarantor. The IRS challenged Bordelon’s claimed loss deductions for 2008 related to Many LLC and Kilgore LLC, asserting he was not at risk under I. R. C. § 465 and lacked sufficient basis in Kilgore LLC under I. R. C. § 704(d).

    Procedural History

    The IRS issued notices of deficiency for the tax years 2008-2011, disallowing loss deductions related to Many LLC and Kilgore LLC on the grounds that Bordelon was not at risk under I. R. C. § 465 and lacked sufficient basis in Kilgore LLC under I. R. C. § 704(d). The Bordelons timely filed petitions with the U. S. Tax Court seeking redetermination of the deficiencies. The Commissioner raised the at-risk issue regarding the Kilgore Loan at trial. The court held that Bordelon’s personal guarantees established sufficient amounts at risk and increased his basis in Kilgore LLC, allowing him to deduct the previously disallowed losses.

    Issue(s)

    Whether Rock Bordelon’s personal guarantees for the Many Loan and the Kilgore Loan established sufficient amounts at risk under I. R. C. § 465 and increased his basis in Kilgore LLC under I. R. C. § 704(d) to allow him to deduct the losses related to Many LLC for 2008 and Kilgore LLC for 2011?

    Rule(s) of Law

    Under I. R. C. § 465, a taxpayer’s loss deductions are limited to the amount for which the taxpayer is considered “at risk,” which includes amounts borrowed with respect to the activity, to the extent the taxpayer is personally liable for repayment or has pledged non-activity property as security. I. R. C. § 465(b)(2)(A), (B). A taxpayer is not considered at risk for amounts protected against loss through nonrecourse financing or guarantees. I. R. C. § 465(b)(4). Under I. R. C. § 704(d), a partner’s loss deduction is limited to his adjusted basis in the partnership, which is increased by the partner’s share of partnership liabilities to the extent the partner bears the economic risk of loss for the liability. 26 C. F. R. § 1. 752-1(a)(1), Income Tax Regs.

    Holding

    The Tax Court held that Bordelon’s personal guarantee of the Many Loan established sufficient amounts at risk under I. R. C. § 465, entitling him to deduct the losses related to Many LLC for 2008. Furthermore, Bordelon’s personal guarantee of the Kilgore Loan increased his basis in Kilgore LLC under I. R. C. § 704(d) and established amounts at risk under I. R. C. § 465, entitling him to deduct for 2011 his share of suspended losses disallowed for 2008.

    Reasoning

    The court applied the “worst-case scenario” analysis to determine whether Bordelon was personally liable for the Many Loan and the Kilgore Loan under I. R. C. § 465(b)(2)(A). The court found that Bordelon was the “obligor of last resort” for both loans, as he had no right to meaningful reimbursement from the primary obligors (Many LLC and AHM for the Many Loan, and Kilgore LLC for the Kilgore Loan) in the event of default. The court also considered the “realistic possibility” of economic loss under I. R. C. § 465(b)(4) and found that Bordelon was not protected against loss, as there were no other guarantors or recourse obligations for the loans. For the Kilgore Loan, the court applied the “constructive liquidation” test under 26 C. F. R. § 1. 752-2(b), Income Tax Regs. , and found that Bordelon’s guarantee made the loan recourse to him, increasing his basis in Kilgore LLC under I. R. C. § 704(d). The court’s reasoning relied on prior case law, including Brand v. Commissioner, 81 T. C. 821 (1983), Abramson v. Commissioner, 86 T. C. 360 (1986), and Melvin v. Commissioner, 88 T. C. 63 (1987), which established the principles for determining personal liability and protection against loss under the at-risk rules.

    Disposition

    The Tax Court ruled in favor of the Bordelons, allowing them to deduct the disallowed 2008 Many LLC loss deductions and the 2011 Kilgore LLC loss deductions. Decisions were to be entered under Rule 155.

    Significance/Impact

    This decision clarifies the application of the at-risk rules under I. R. C. § 465 and the impact of personal guarantees on a taxpayer’s basis in partnerships under I. R. C. § 704(d). It provides guidance for taxpayers and tax professionals on the deductibility of business losses, particularly in cases involving personal guarantees of business loans. The ruling emphasizes the importance of the “worst-case scenario” and “realistic possibility of economic loss” analyses in determining whether a taxpayer is at risk for borrowed amounts. The decision also highlights the significance of the “constructive liquidation” test in determining whether a partnership liability is recourse to a partner, affecting the partner’s basis in the partnership. This case may influence future tax planning and litigation involving personal guarantees and the at-risk rules.

  • Peters v. Commissioner, 89 T.C. 423 (1987): When Limited Partners’ Personal Guarantees Do Not Place Them ‘At Risk’ Under Section 465

    Peters v. Commissioner, 89 T. C. 423 (1987)

    Limited partners’ personal guarantees do not place them ‘at risk’ for amounts beyond their cash contributions when they have a right of subrogation against the partnership.

    Summary

    Touraine Co. , a limited partnership, entered into an equipment sale-leaseback transaction on December 31, 1978. The IRS challenged the partnership’s tax year start date and the limited partners’ at-risk status. The Tax Court held that Touraine’s tax year began on December 29, 1978, when it acquired new partners and assets. Additionally, the court ruled that the limited partners were not at risk for amounts beyond their cash contributions because their personal guarantees were subject to a right of subrogation against the partnership. This decision clarified the application of the at-risk rules under Section 465, affecting how limited partners’ liabilities are assessed in tax-motivated transactions.

    Facts

    Touraine Co. was initially formed on January 4, 1978, but had no assets, liabilities, or business until December 29, 1978, when it acquired new partners and significant assets. On December 31, 1978, Touraine entered into an equipment sale-leaseback transaction with Datasaab Systems, Inc. The limited partners made cash contributions and executed personal guarantees to Manufacturers Hanover Trust Co. for portions of the partnership’s debt. These guarantees were structured to cover expected tax losses minus capital contributions and were legally enforceable, but limited partners retained a right of subrogation against the partnership.

    Procedural History

    The IRS issued deficiency notices to the petitioners, challenging the start date of Touraine’s tax year and the at-risk status of the limited partners. The Tax Court consolidated the cases and heard arguments on the issues, ultimately ruling on the start date of the tax year and the at-risk status based on the personal guarantees.

    Issue(s)

    1. Whether Touraine’s first tax year commenced on December 29, 1978, when it acquired new partners and assets.
    2. Whether the limited partners were at risk for amounts beyond their cash contributions due to their personal guarantees.

    Holding

    1. Yes, because Touraine’s partners did not have a good-faith intent to presently conduct an enterprise with a business purpose until December 29, 1978.
    2. No, because the limited partners were not at risk beyond their cash contributions due to their right of subrogation against the partnership under the personal guarantees.

    Court’s Reasoning

    The court applied the principles from Torres v. Commissioner and Sparks v. Commissioner, determining that a partnership exists for tax purposes when the parties intend to join together in the present conduct of an enterprise. Touraine’s tax year began on December 29, 1978, when it acquired new partners and assets, reflecting this intent. Regarding the at-risk issue, the court followed Brand v. Commissioner, holding that the limited partners’ personal guarantees did not place them at risk beyond their cash contributions due to their right of subrogation against Touraine. The court distinguished Abramson v. Commissioner, noting that in Peters, the guarantees did not extend to the entire debt and were not primary obligations. The court emphasized that the at-risk rules aim to limit deductions to amounts for which the taxpayer is truly at risk of economic loss.

    Practical Implications

    This decision impacts how limited partners’ at-risk status is determined in tax-motivated transactions, particularly those involving personal guarantees. Practitioners must ensure that guarantees do not provide a right of subrogation to qualify as at-risk amounts. This ruling may lead to increased scrutiny of partnership agreements and financing structures to ensure compliance with Section 465. Businesses engaging in similar transactions should carefully structure their financing to avoid unintended tax consequences. Subsequent cases like Brand v. Commissioner and Abramson v. Commissioner continue to be distinguished based on the specifics of the guarantees and the presence of subrogation rights.