United States Tax Court

United States Tax Court

T.C. Memo. 2023-114

SHORT STOP ELECTRIC, INC.,

Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent

—————

Docket No. 11359-20.

Filed September 11, 2023.

—————

Thomas Edward Brever, for petitioner.

Lisa R. Jones and Christina L. Cook, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

HOLMES, Judge: Short Stop Electric is an electrical contractor

mostly owned by its president, Bob Boyum. Since 2009 he has extended

to his company what he calls a “revolving line of credit.” In 2015 and

2016, Short Stop did not actually borrow money from, or pay interest to,

Boyum. Boyum instead increased the principal of the loan by the

amount of interest that he said the company owed him. Short Stop

recorded the interest as paid even though the corporation uses the cash

method of accounting.

The Commissioner was shocked to discover what was going on

and resists the characterization of these accounting entries as

deductible interest payments. He charges as invalid Short Stop’s net

operating losses (NOLs) that flowed from these interest payments. He

challenges deductions that the company claimed for its purchase of

several depreciable assets. And he wants penalties as well.

Served 09/11/23

2

FINDINGS OF FACT

[*2]

I.

Short Stop’s Business and Accounting

Short Stop Electric sells commercial, industrial, and residential

electric services. Its owners, Boyum and his wife Michelle, incorporated

it in Minnesota back in 1989. At the time of incorporation, and through

the tax years at issue, Bob owned 96% of the stock and Michelle owned

the rest. Bob is president of the company and handles the “bidding,

billing, pricing, [and] acquiring material[s].” Michelle helped where she

could with administrative duties, payroll, and deliveries but, as Bob

credibly testified, her primary focus was raising the nine Boyum

children.

Boyum chose to have Short Stop be a C corporation under the

Code. 1 He also chose to adopt the cash method of accounting. 2 One might

regard this as an eccentric choice for a small, privately owned business

because income from C corporations is taxed twice. See, e.g., Pierre v.

Commissioner, 133 T.C. 24, 30 (2009), supplemented by 99 T.C.M. (CCH)

1436 (2010). The Code taxes it first at the corporate level as corporate

income. And then when a C corporation distributes anything that’s left

to its shareholders, they must themselves include the dividend in their

own taxable income.

Small-business owners understandably want to insulate

themselves from this aspect of the tax system. The most popular ways

to do so are to elect to be taxed under subchapter S of the Code, 3 or to

organize as a limited liability company (LLC) and choose to be taxed as

A “C corporation” is a corporation that is taxed under subchapter C of

chapter 1 of the Code, §§ 301–385. (All section references are the Internal Revenue

Code in effect for the years in issue, and all Rule references are to the Tax Court Rules

of Practice and Procedure, unless we say otherwise.)

1

2 A cash-basis taxpayer recognizes income in the year that it actually receives

that income. It must likewise deduct its expenses in the year in which it pays them.

Treas. Reg. § 1.446-1(c)(1)(i). In contrast are accrual-method taxpayers who recognize

income and deduct expenses in the year in which the event occurs that secures them

either the right to that income or the obligation to make that payment. See id.

subdiv. (ii).

3 If a business satisfies the requirements of section 1361, it may elect to become

an “S corporation” and in turn avoid paying corporate tax. Unlike a C corporation, an

S corporation’s income and losses are treated like that of a partnership. § 1366. They

flow through to the shareholders directly and therefore avoid the first level of double

taxation.

3

[*3] a partnership or a sole proprietorship. 4 Choosing to become an

S corporation or an LLC means no tax at the corporate level, but this

case is about how Short Stop and Boyum tried to invent a third way to

minimize double taxation. Short Stop’s returns show some considerable

success. Over the years, including 2015 and 2016, the company reported

little if any taxable income. Boyum accomplished this through what he

called a revolving line of credit. He would record that he had lent money

to Short Stop. Short Stop would not make any regular interest payments

to Boyum. He would instead, at the end of the year, figure out how much

interest he wanted Short Stop to owe him, calculate what interest rate

would generate that sum, apply that rate, and add the resulting amount

to the principal of the loan.

Short Stop totaled these additions to principal and claimed them

as interest deductions on its returns. Remarkably, the Boyums reported

this interest that they didn’t receive on their joint returns, which in turn

increased their own taxable income. Boyum started doing this years

before 2015. It sparked the IRS’s interest and led to an audit of Short

Stop’s 2006 return. During that audit, the revenue agent explained to

Boyum that any loan that he extends to Short Stop cannot generate

interest deductions on paper to offset income in cash. The agent

ultimately decided to suspend the examination as a “no change” since he

believed that Boyum was receptive, eager to learn, and now aware that

the government did not consider his attempted transformation of

retained earnings into deductible interest to be valid.

This may not have been the most effective way for the IRS to

handle what it thought of as a compliance problem. Short Stop and

Boyum continued to operate the “revolving line of credit” after the audit

much as they had before. In 2015 Short Stop recorded the interest

payments that it said it owed Boyum at the end of the year as both

interest paid and an increase to principal. Then, in 2016, Short Stop’s

accounting became stranger still.

To understand how strange, we have to look back at 2012 for

something else Boyum began to do with Short Stop’s books. In that year,

Boyum had decided to buy an interest in a cabin owned by John and

Wendolyn Mickman on Coon Lake in Minnesota. He formed Orfei’s

4 The Code does not impose the same taxing regime on all business entities.

The IRS has created a “check the box” election that allows an entity such as an LLC to

elect to be taxed either as a corporation or as a passthrough entity. Treas. Reg.

§ 301.7701-3(a). We do note that the “check the box” regulations did not become

effective until 1997, while Short Stop was incorporated in 1989.

4

[*4] Landing, LLP, with the Mickmans, and its stated purpose was to

own and operate the cabin. Boyum paid $90,000 from his personal

account in exchange for a 25% interest in the partnership. But he then

put that interest in Short Stop’s name. The Mickmans kept the other

75% interest, and never actually transferred title to the cabin to the

partnership.

Boyum said he had Short Stop buy an interest in the cabin

because he hoped to use the corporation to develop the property into a

five-plex or as an investment. Short Stop increased its interest in Orfei’s

Landing in 2014, when $180,000 flowed to the Mickmans for both an

additional 50% interest in the partnership and an option to buy the

remaining 25%. The agreement allowed the Mickmans to continue to

control the property but for Short Stop itself to use the cabin. The

payment for this increased interest also came from Boyum’s personal

account. This time, the agreement required the Mickmans to transfer

the title of the property to the partnership, and a property-tax notice in

the record shows they finally did. Shortly thereafter, Short Stop

exercised the option and bought the remaining 25% interest. Nothing in

the record tells us where this money came from.

The accounting for this was quite odd. Boyum had been spending

his own money to buy these increasing shares of the cabin held in the

name of a partnership in which Short Stop owned an interest. But it

wasn’t until 2016 that it showed up on the corporation’s books. And it

showed up as an increase in the principal of the loan that Short Stop

recorded that they had received from Boyum. There’s nothing in the

record that tells us why this increase did not take place until 2016, years

after the transactions took place. 5

Short Stop never did develop the cabin into a five-plex. Boyum

claims that fiscal trouble stemming from the Great Recession of 2008

and 2009 caused the city to change its plans to bring sewer and water

service out to the cabin. He testified that Short Stop could not move

forward with the plan to develop the cabin without those connections.

One might wonder why Short Stop would start buying shares in

the cabin starting in 2012 when these obstacles to development were

5 The details of this story are not essential to our analysis of the contested

issues. We also note that we base it on the language of the contract that the parties

stipulated into evidence, and not their somewhat different summary that they also

stipulated. See Jasionowski v. Commissioner, 66 T.C. 312, 318 (1976) (holding that

stipulated facts can be superseded when they are clearly contrary to the record).

5

[*5] already in place in 2009, but the company found other uses for the

property. It used the cabin for parties, to entertain employees and

clients, and to enable the Boyums to spend time on a boat that the

corporation owned and made available to them and their guests. Short

Stop also let Boyum’s son and his friends live there during the school

year. Though Boyum said the boys were both renters and caretakers, we

find that they paid no rent and the record has no documentation of any

caretaking duties.

There is one last oddity in Short Stop’s accounting. In 2010, Short

Stop lent $25,000 to an unrelated company named Fogerty

Investments. 6 Fogerty made payments on this loan in 2016, but not to

Short Stop—at least not directly. Instead of repaying the loan directly

to Short Stop, Fogerty sent money to Boyum. Short Stop recorded some

of these payments in its ledger as interest payments from Short Stop to

Boyum. 7

The Commissioner also thought that Short Stop was overloading

its deductions for business equipment on its 2016 return. One of these

deductions was for the cost of the boat on Coon Lake that Boyum used

to entertain employees and clients. Short Stop has since conceded that

the cost of the boat isn’t deductible. But it very much contests the

Commissioner’s disallowance of deductions for a forklift and a plow

attachment. 8 Boyum used the plow to clear snow from the driveway to

6 Though the total sum of the loan is unclear, at least $25,000 was lent by Short

Stop to Fogerty in 2010.

7 Part of the payment to Boyum in March was recorded in the ledger. The

November payments made to Boyum were entirely absent from the ledger.

8 The stipulation of facts states that Boyum purchased a plow and a forklift

that attaches to the plow. It also notes that the forklift is also referred to as a “tractor”

throughout the record. Though forklifts and tractors are distinct, the notice of

deficiency conflated the two and referred to Boyum as having purchased a tractor as

opposed to a forklift. The notice also neglects to mention whether either the plow or

the forklift was an attachment. This error is harmless since both forklifts and tractors

are qualified nonpersonal property under section 179. See Treas. Reg. § 1.2745(k)(2)(ii)(K) and (Q); John C. Hom & Assocs. v. Commissioner, 140 T.C. 210, 213 (2013)

(“Mistakes in a notice will not invalidate it if there is no prejudice to the taxpayer.”)

At trial, however, Boyum testified that the plow and the forklift were both

attachments, claiming that the plow was attached to a one-ton pickup truck and the

forklift was attached to a tractor. Facts that parties have stipulated to are not

disregarded lightly, but we can treat them as superseded when “facts are clearly

contrary to the facts disclosed by the record.” See Jasionowski, 66 T.C. at 318. The

record here is inconsistent, as we have the notice referring to a tractor and a plow

6

[*6] both his home and Short Stop’s building, which is near the Boyums’

home and shares a driveway with it. Boyum would sometimes plow his

neighbor’s driveway too. He used the forklift both to move snow and to

move the pallets on which Short Stop received and stored some of its

business supplies.

II.

Returns

On its 2015 return Short Stop reported $45,000 in interestexpense deductions, more than $30,000 of which came in the form of

additions to the principal of the loan owed to Boyum. Adding deductible

but unpaid interest to the principal had a key benefit for Short Stop. It

completely offset its taxable income and generated an NOL that the

company would carry forward from year to year. Short Stop prepared an

NOL worksheet for 2015 that showed the calculation, but did not attach

it to its 2015 return. On this worksheet it reported having a total

available NOL carryforward of over $50,000 to use in 2015, since it had

been adding unpaid interest to principal for years.

On its 2016 return, Short Stop reported paying over $115,000 in

interest to Boyum. The allocation of those payments is:

Source of Interest

Unidentified 9

Amount Paid

$336.00

Fogerty Payments

10,500.00

Increase in Principal

104,287.61

Total

$115,123.61

Short Stop used its remaining NOL to offset a chunk of its 2016

taxable income.

without mention of attachments, and Boyum’s testimony characterizing both the

forklift and the plow as attachments. The stipulation addresses the

mischaracterization in the notice of deficiency and characterizes the plow as an

attachment to the forklift. On this record, there is not clear evidence that the facts

stipulated are erroneous, and so we will rely on them in our analysis.

9 This payment was attributable to “BOB BOYUM SHIN HOSPITALITY INT.”

We have no idea what this means.

7

[*7] Short Stop also reduced its tax bill by deducting the cost of the

boat, as well as the plow attachment and the forklift, under section 179.

Here are those numbers:

Description of Property

III.

Cost

Boat World Princecraft

$32,750

Trueman Walters Forklift

31,795

Crysteel-Plow

5,155

Audit, Petition, and Trial

Short Stop received a notice of deficiency in which the

Commissioner disallowed the interest deductions. He also disallowed

the NOLs taken for both years because he was disallowing the interest

deductions that generated them. And he disallowed Short Stop’s section

179 deductions for the plow attachment and the forklift, as well as for

the boat, because Short Stop did not primarily use them for business.

He then juiced the total a bit more with 20% penalties under section

6662 for negligence and substantial understatement.

Short Stop timely petitioned the Court. We tried the case virtually

on a St. Paul calendar. Short Stop is a Minnesota corporation and has

its principal place of business in Minnesota, so appellate venue

presumptively lies in the Eighth Circuit. See § 7482(b)(1)(B).

OPINION

There are four issues left for us to decide:

•

Short Stop’s entitlement to interest deductions on its 2015 and

2016 returns;

•

Short Stop’s entitlement to the NOL that it carried forward to

those returns;

•

Short Stop’s entitlement to the section 179 deductions that it

claimed on its 2016 tax return; and

•

whether penalties are appropriate.

8

[*8] I.

The Interest Deductions

The Commissioner contends that Short Stop’s interest deductions

weren’t really for interest, didn’t have a business purpose, and aren’t

substantiated. The Commissioner took a holistic approach in attacking

the deductions, but we’ll separately analyze the deductions associated

with the interest allocated to the principal of the “line of credit” and the

deductions associated with Short Stop’s loan to Fogerty. 10

A.

Deducting Unpaid and Accumulated Interest

The Code’s general rule is that “all interest paid or accrued within

the taxable year” can be deducted so long as no other exceptions or

exemptions in the Code apply. See § 163(a). For a cash-basis taxpayer

deductible interest must be paid and not just owed. Treas. Reg. § 1.4611(a)(1). Paid means paid in cash or its equivalent. Eckert v. Burnet, 283

U.S. 140, 141 (1931); Davison v. Commissioner, 107 T.C. 35, 41 (1996),

aff’d, 141 F.3d 403 (2d Cir. 1998). Merely delivering a promissory note

for interest, for example, is not paying interest and isn’t deductible

because a note is a promise to pay and not an actual payment. Don E.

Williams Co. v. Commissioner, 429 U.S. 569, 577–78 (1977); Davison,

107 T.C. at 41.

Capitalizing interest, which is the term for what Short Stop says

it was doing, is the addition of unpaid interest to the principal of a loan.

But courts have consistently held that adding unpaid interest to a loan

is not the same as paying it. See, e.g., Heyman v. Commissioner, 70 T.C.

482, 485–87 (1978), aff’d, 652 F.2d 598 (6th Cir. 1980). Capitalizing

interest postpones an obligation to pay; it does not discharge that

obligation. Id.

This is settled law, so well settled that we don’t have to analyze

whether the relationship that Boyum had with his company was truly

that of a creditor and debtor, or whether Short Stop used the money that

it “borrowed” from him for business purposes. Since Short Stop operates

on a cash basis, it is enough for us to find that allocations to the principal

of the loan are not the payment of interest and are therefore not

deductible.

10 The Commissioner also disallowed a $336 deduction for interest paid to Shin

Hospitality. Short Stop never substantiated the payment or the amount. It also

presented no evidence at trial about it. Short Stop bore the burden of proof, so we find

for the Commissioner on this issue.

9

[*9]

B.

Fogerty Payments

Our analysis of the payments from Fogerty has to be different

because these payments were actually made and ended up in Boyum’s

bank account, not Short Stop’s. The Commissioner says that paying

interest through a third party is a breach of traditional loan practice.

Maybe. But it is also “well settled that if a taxpayer’s obligation is paid

by a third party, the effect is the same as if the third party had paid the

taxpayer who in turn paid his creditor.” Chapman v. Commissioner, 73

T.C.M. (CCH) 2405, 2412 (1997); see also United States v. Boston &

M.R.R., 279 U.S. 732 (1929); Old Colony Trust Co. v. Commissioner, 279

U.S. 716 (1929). That the payments were made from Fogerty to Boyum

does not render them per se nondeductible by Short Stop.

The IRS doesn’t contest that Fogerty and Short Stop had a debtorcreditor relationship. But we have to look more closely at the facts to

figure out whether Fogerty’s payment of interest directly to Boyum

discharged an obligation that Short Stop owed Boyum. And for that we

have to figure out whether Boyum and Short Stop themselves had

created a debtor-creditor relationship with the “line of credit.” Section

163(a) requires not only proof that a payment is a payment of interest,

but also that it is interest derived from a genuine debt. Midkiff v.

Commissioner, 96 T.C. 724, 734 (1991), aff’d sub nom. Noguchi v.

Commissioner, 992 F.2d 226 (9th Cir. 1993). A genuine debt is “an

existing, unconditional, and legally enforceable obligation for the

payment of a principal sum.” Howlett v. Commissioner, 56 T.C. 951, 960

(1971); see also Midkiff, 96 T.C. at 744.

Short Stop’s ledger accounted for these payments from Fogerty to

Boyum as interest paid by Short Stop to Boyum. The Commissioner

argues that the ledger is wrong—that the correct characterization of

Fogerty’s payments to Boyum is not the legal equivalent of Fogerty’s

paying interest to Short Stop and Short Stop’s paying interest to Boyum

since the money never touched Short Stop’s account. This makes a

difference because the alternative characterization would be as a

dividend, and dividends paid out usually are not deductible by the

corporation that makes them. See § 162(a)(1); Treas. Reg. § 1.162-7(b)(1);

see also Heil Beauty Supplies, Inc. v. Commissioner, 199 F.2d 193, 194

(8th Cir. 1952) (“Any payment arrangement between a corporation and

a stockholder . . . is always subject to close scrutiny for income tax

purposes, so that deduction will not be made, as purported salary, rental

or the like, of that which is in the realities of the situation an actual

distribution of profits.”)

10

[*10] Our analysis focuses on whether these payments were interest or

dividends, which is a question of fact. Delta Plastics, Inc. v.

Commissioner, 85 T.C.M. (CCH) 940, 943 (2003). And it’s a question of

fact that requires us to look for the objective evidence found in the terms

and conditions of the agreement as well as evidence of the parties’

subjective intent. United States v. Uneco, Inc. (In re Uneco, Inc.), 532

F.2d 1204, 1209 (8th Cir. 1976).

It’s also a question discussed in many cases. The Eighth Circuit

tells us to consider several factors:

•

whether the corporation is so grossly undercapitalized that the

loans are in fact needed for capital purposes and are actually

intended to be risk capital rather than a loan; 11

•

whether the purported loans were made in proportion to equity

holdings;

•

whether the repayment of the loan was predicated on the success

of the venture;

•

whether there was a fixed date for payment of the note and a

reasonable expectation of payment by that date;

•

whether the obligation to pay was subordinated to other corporate

debts;

•

whether third parties would have made the loan under the same

conditions;

•

whether the claimed loan was secured by a mortgage or

otherwise;

•

whether a provision was made for a sinking fund to retire the

loan;

11 In Uneco, the Eighth Circuit made clear that excluding this first factor, the

rest of the factors are not aimed at discerning the subjective intent of the parties. It

held that “the controlling principle should be that any transaction which is

intrinsically clear upon its face should be accorded its legal due unless the transaction

is a mere sham or subterfuge set up solely or principally for tax-avoidance purposes.”

Uneco, 532 F.2d at 1208. The remaining nine factors are aimed at discerning whether

the transaction objectively creates a debtor-creditor relationship.

11

[*11]

• whether the person making the purported loan participated in the

management of the corporation; and

•

whether the corporation had a large proportion of debt to equity. 12

J.S. Biritz Constr. Co. v. Commissioner, 387 F.2d 451, 457–58 (8th

Cir. 1967), rev’g 25 T.C.M. (CCH) 1175 (1966).

No one factor is decisive, and all factors may not be equal. Dixie

Dairies Corp. v. Commissioner, 74 T.C. 476, 493 (1980) (citing John

Kelley Co. v. Commissioner, 326 U.S. 521, 530 (1946)). Because debtequity questions can arise in so many different circumstances, not all

the factors may even be relevant to every case—especially when the case

involves a shareholder loan to a close corporation. Id. at 494; J.S. Biritz

Constr. Co., 387 F.2d at 456–58. The caselaw teaches us that a true

debtor-creditor relationship exists when there is a business purpose for

making the loan “and the transaction is not a tax-avoidance scheme or

a sham or masquerade.” J.S. Biritz Constr. Co., 387 F.2d at 458. In

addition to the objective inquiry focused on the structure of the

transaction, our analysis hinges on “whether there was an intent to

create a debt with a reasonable expectation of repayment and, if so,

whether that intent comports with the economic reality of creating a

debtor-creditor relationship.” Delta Plastics, Inc., 85 T.C.M. (CCH)

at 943 (citing Litton Bus. Sys., Inc. v. Commissioner, 61 T.C. 367, 377

(1973)).

Boyum’s revolving line of credit with Short Stop began with an

agreement dated December 31, 2009. The agreement gave Short Stop

12 In addition to these ten factors, the Eighth Circuit also set out in Uneco a

thirteen-factor test from the Fifth Circuit: “(1) the names given to the certificates

evidencing the indebtedness; (2) the presence or absence of a maturity date; (3) the

source of the payments; (4) the right to enforce the payment of principal and interest;

(5) participation in management; (6) a status equal to or inferior to that of regular

corporate creditors; (7) the intent of the parties; (8) ‘thin’ or adequate capitalization;

(9) identity of interest between creditor and stockholder; (10) payment of interest only

out of ‘dividend’ money; (11) the ability of the corporation to obtain loans from outside

lending institutions; (12) the extent to which the initial advances were used to acquire

capital assets; and (13) the failure of the debtor to pay on due date or to seek a

postponement.” Uneco, 532 F.2d at 1208. Excluding the seventh factor, the Eighth

Circuit found that these factors are also objective and should be used to determine

whether a transaction on its face is an actual loan. Id. Though the intent of the parties

is a relevant factor when discerning whether a debtor-creditor relationship exists, it is

one that we weigh together with the objective factors. See id.

12

[*12] the right to borrow up to $1 million from Boyum, with a maturity

date of December 2019. 13 The agreement did not specify an interest rate,

but instead allowed Boyum to determine the interest rate each year. The

agreement required Short Stop to make monthly interest payments or

add unpaid interest to the loan principal. Along with increasing the

principal, if the interest payments were not paid within 10 days of

becoming due, Short Stop would be in default. Defaulting on the loan

allowed Boyum to demand the principal and interest of the loan be

immediately payable.

Boyum routinely failed to collect interest on the loan at the end of

each month and instead waited until the end of the year to decide what

interest rate to charge. After deciding the rate, he allocated the interest

owed retroactively to each month. Short Stop then recorded the interest

payments in its ledger as funds distributed to Boyum even though they

really weren’t.

We therefore find that there was a written agreement between

Boyum and Short Stop defining the terms of the loan, but we specifically

find that these terms were fiction in practice. Short Stop did not

distribute interest to Boyum on a monthly basis, and under the loan

agreement this meant that the unpaid interest was automatically

capitalized. Short Stop’s failure to make timely payments also triggered

the default clause that would allow Boyum to demand payment on the

principal and the interest whenever he wanted to (though he never did).

This tends to suggest that Boyum was not an actual creditor and the

sum provided to Short Stop was a capital contribution.

There’s also the exceptional strangeness of the way Boyum

determined the interest rate. He did so at the end of the year based in

part on Short Stop’s ability to pay. Boyum testified that he determined

what rate to apply to the loan by reviewing the general market and

Short Stop’s financial wellbeing. Repayment dependent on the fortunes

of a business is generally a strong sign that a payment is a dividend

rather than interest. Dixie Dairies Corp., 74 T.C. at 495. We recognize

13 This was a revolving line of credit and Short Stop did not take out the

entirety of the $1 million. The record shows that on the general ledger in 2014, there

was a beginning balance of around $350,000 on the loan. There is no indication of when

the money up to this point was distributed to Short Stop. From 2014 until 2016 the

ledger shows that Short Stop increased its loan throughout the years but there is no

clear explanation of where the loan money came from. Included in these loans is the

interest that Boyum “loaned back” to the company and the money that he used to buy

into the partnership that owned the Coon Lake cabin.

13

[*13] that debt can have adjustable interest rates, but such rates are

adjustable in arms-length deals based on a formula that “leaves nothing

to the discretion of the corporate directors.” Monon R.R. v.

Commissioner, 55 T.C. 345, 360–61 (1970). Here there was no formula,

just unfettered discretion on the part of the putative creditor. No

reasonable debtor would agree to a deal like this. This is a strong

indicator that the loan was actually retained earnings. 14

These factors would themselves be sufficient to support our

finding that the shareholder “loans” were actually shareholder equity,

but the real surge that fries petitioner’s argument is Boyum’s intent in

creating the loan. This is the rare case where we have good evidence of

that subjective intent. Boyum admitted that his goal for this “line of

credit” was to convert as much of the balance as possible to principal. 15

He explained that he believed that when he retired or sold Short Stop,

he could take money out of the corporation as repayment of loan

principal, and thus avoid paying tax on what would otherwise be a

capital gain.

He also thought it benefited Short Stop because recording some

portion of the retained earnings as interest paid would create deductions

that offset taxable income. The more interest allocated to principal, the

larger the deduction. This would be a tax miracle if it worked. It is

perfectly reasonable for a small-business owner to accumulate capital in

his company. What is unreasonable is to argue that relabeling equity a

“revolving line of credit” can make retained earnings deductible. After

Boyum was expressly told by the IRS during the 2006 audit that the

Code did not permit this relabeling, we find it difficult to believe that

Short Stop’s continuing to do so was motivated by anything other than

a desire to shelter income from tax.

14 We don’t need to walk through each of the factors enumerated by the Eighth

Circuit since “each case turns upon its particular facts and . . . the varying indicia

applied in determining the issue may or may not have relevancy to a particular case.”

Uneco, 532 F.2d at 1207. The specific facts that we find here enable us to determine

that the arrangement between Boyum and Short Stop did not create a debtor-creditor

relationship to an objective viewer.

15 Boyum also testified that another motivation for providing Short Stop with

the loan was the fact that Short Stop had previously been unable to secure financing

from banks without Boyum’s securing the loans with his personal assets. Even if we

believed Boyum’s testimony on this point, Short Stop’s inability to secure a loan from

banks is itself an indicator that the “loans” were really “retained earnings.”

14

[*14] We find for the Commissioner and disallow the interest

deductions. Short Stop is not entitled to deductions for what it called

additions to the principal amount of what it called a loan from Boyum;

neither is it entitled to deductions for repayment of what it called a loan

in the form of payments from Fogerty to Boyum directly.

II.

NOL

Our finding on the interest question lets us short circuit our

discussion of the next issue—whether Short Stop is entitled to the large

NOL deductions that it claimed because of those interest deductions.

Section 172 allows a taxpayer to take an NOL carryover from earlier

years and an NOL carryback from later years when its taxable income

in the current year is more than zero. § 172(a), (b)(2). A taxpayer must,

however, elect to carry NOLs forward. Without an election to do so, the

Code’s default rule is to apply the NOL to the two preceding years.

§ 172(b)(1) and (2). If the loss is not fully absorbed after carrying it back,

only then can it be carried forward through the next 20 years. Id. The

loss must also be consumed in the earliest year when there is income

available to be offset. § 172(b)(2).

Short Stop claimed an NOL of about $20,000 for 2015 and about

$33,000 for 2016. The Commissioner argues that had the interest

deductions Short Stop claimed in prior years been properly disallowed,

there would either not have been any NOL, or if there had been, it would

have been absorbed by taxable income earned before 2015.

Short Stop has the burden here. See Treas. Reg. § 1.6001-1(a);

INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). This requires

it to prove both the existence and the amounts of its claimed NOL

carrybacks and carryforwards. See Rule 142(a); Keith v. Commissioner,

115 T.C. 605, 621 (2000); Jones v. Commissioner, 25 T.C. 1100, 1104

(1956), rev’d and remanded on other grounds, 259 F.2d 300 (5th Cir.

1958).

In this case, that means Short Stop had to prove that the NOL

carryforwards it took in 2015 and in 2016 were real and would not have

been absorbed by a previous year. See Leitgen v. Commissioner, 42

T.C.M. (CCH) 1130, 1131–32 (1981). Short Stop first argues that we

should not look at the truth of its claims to NOLs for tax years before

2015. Section 6214(b) tells us, however, that we may consider facts

relating to years not in issue that are relevant to a year that is before

us. See, e.g., Lee v. Commissioner, 91 T.C.M. (CCH) 999, 1001 (2006).

15

[*15] This is especially important in the case of determining an NOL,

since correcting any errors made in earlier tax years might well lead to

the reduction or elimination of an NOL that a taxpayer wants to use for

later years.

The NOL carryforward that Short Stop used to offset its 2015 and

2016 income was derived from a nearly $19,000 NOL it claims to have

suffered in 2010 and a nearly $34,000 NOL it claims to have suffered in

2014. Short Stop did not, however, submit any evidence that it elected

to waive the two-year NOL carryback for either of those losses. We do

know that Short Stop was taking interest deductions from the

shareholder “loan” in years before 2015, but this just complicates things

a bit more, because we have to exclude any such deductions as we try to

figure out whether it had a real loss and how much that loss was.

We can’t do that here because Short Stop didn’t give us evidence

of the amount of the interest-expense deductions it claimed that were

attributable to the shareholder loan in 2011 or earlier years. Short Stop

did report a nearly $53,000 loss attributable to unpaid “interest” for

2012, and then another $20,000 loss for 2013. We have to disregard

those bogus losses, but that then means that if Short Stop actually had

an NOL in 2010, it would have been fully absorbed in 2012 alone.

Short Stop’s situation in 2014 is a bit different. Its $34,000 NOL

for 2014 comes mostly from the bogus interest deduction, and we have

to reduce the NOL by the portion of the loss generated from this

deduction. But that leaves Short Stop with a potential carryover loss of

only $762.68. And even this loss would need to first be carried back to

the two preceding years before it could be carried forward to the 2015

tax year, because Short Stop did not elect to waive the carryback on its

return. Without the disallowed interest deductions there is no NOL at

the beginning of Short Stop’s 2015 tax year for it to carry forward.

Short Stop also has a procedural problem here. There is a

regulation that requires a taxpayer to substantiate its claim to this

deduction by filing sufficient evidence of its NOL with its return. This

includes a “concise statement setting forth the amount of the net

operating loss deduction claimed and all material and pertinent facts

relative thereto, including a detailed schedule showing the computation

of the net operating loss deduction.” Treas. Reg. § 1.172-1(c). Though

Short Stop had NOL carryover worksheets, it did not file them with

either its 2015 or 2016 return. This alone disqualifies the company from

taking the deduction. See Amos v. Commissioner, 124 T.C.M. (CCH) 289,

16

[*16] 292 (2022) (first citing Ghafouri v. Commissioner, 111 T.C.M.

(CCH) 1023 (2016); and then citing Treas. Reg. § 1.172-1(c)).

Even if Short Stop had submitted the required form, the only

evidence that it gave us of any of its losses, whether due to these

“interest” deductions or not, were its returns and the worksheet. It

introduced no evidence that the information on the worksheet was

accurate, and a “tax return is merely a statement of a taxpayer’s claim

and does not establish the correctness of the facts stated therein.” Fitch

v. Commissioner, 104 T.C. M. (CCH) 828, 835 (2012). This too is a failure

of substantiation. See Jones, 25 T.C. at 1104; McRae v. Commissioner,

118 T.C.M. (CCH) 476, 482 (2019); Lee, 91 T.C.M. (CCH) at 1001.

By disallowing the interest-expense deductions that Short Stop

took in prior years, any loss generated from 2010 or 2014 would have

been fully absorbed and left nothing to carry forward to 2015, let alone

to 2016. The disallowance of the deduction also almost entirely

dissipates any NOL that was generated in 2014. Even if there was a loss,

Short Stop failed to submit an NOL worksheet with its returns, which

alone disqualifies it from taking an NOL deduction. And if all this were

not enough, Short Stop failed to substantiate any remaining losses that

it carried forward.

III.

Section 179 Deductions

The Commissioner next wants us to disallow Short Stop’s section

179 deductions for the plow attachment and forklift. Section 179 allows

a taxpayer to deduct the full cost of an asset in the year of purchase,

even if it will use the asset for years to come. § 179(a). 16 (Short Stop

conceded the boat as nondeductible before trial.) There are limits—a

dollar limit, § 179(b)(1), an aggregate-taxable-income limit, § 179(b)(3),

and a limit on using section 179 to deduct the cost of certain passenger

vehicles, § 179(b)(5).

The controversy in this case, however, has a more conventional

source: the Commissioner contends that Short Stop didn’t use the plow

16 Section 179 property is defined as tangible personal property which is section

1245 property and is “acquired by purchase for use in the active conduct of a trade or

business.” § 179(d)(1). Section 1245 property is any property that is subject to the

depreciation allowances under section 167. § 1245(a)(3). Since all section 179 property

is a subset of section 1245 property absent a section 179 election, Short Stop would

have been able to deduct only depreciation rather than the full cost of the property.

See §§ 1245(a)(3), 167(a).

17

[*17] attachment or the forklift for its business. Boyum heartwarmingly

testified about posing some of his progeny in the bucket of the snowplow

for a photo op. If that were the only problem, it would not be

disqualifying—the test is not that property has to be exclusively used in

business; it is whether it is predominantly used for business. Treas. Reg.

§ 1.179-1(d)(1). “Predominantly” means more than half: if a taxpayer

uses the property more than 50% of the time in its business, then “the

portion of the cost . . . attributable to the trade or business use” can be

deducted to the extent that it does not exceed the general limitations of

section 179. Treas. Reg. § 1.179-1(d)(1), (e)(2).

The problem is one of proof. A taxpayer who claims a deduction

under section 179(a) has to substantiate it with proof of where and when

it got the property, when it placed the property into service, and how

much it paid. Treas. Reg. § 1.179-5(a). We may estimate the amount, but

there must be persuasive evidence that it paid at least the amount that

it claimed. Boyd v. Commissioner, 122 T.C. 305, 320 (2004).

The rules are stricter for property that is listed in section

274(d)(4). Listed property forces a taxpayer to show proof of (1) its cost,

(2) the time it was bought, and (3) a description of the expense’s business

purpose. Id.; Temp. Treas. Reg. § 1.274-5T(b)(6).

That usually means a contemporaneous log, diary, trip sheet, or

something similar that substantiates how much a vehicle was actually

used for business rather than personal purposes. Temp. Treas. Reg.

§ 1.274-5T(c). A taxpayer without contemporaneous records has a bigger

problem. It must produce other credible evidence sufficient to

corroborate its own statements concerning business use. Id. Under this

heightened burden, we may not provide estimates of the appropriate

deduction if the taxpayer does not fully substantiate its expenses. Boyd,

122 T.C. at 320.

Section 274 therefore requires that we first analyze whether and

when the Code treats attachments as the vehicles to which they are

attached. We know that listed property includes any passenger

automobile. Treas. Reg. § 1.280F-6(b)(1)(i). A “passenger automobile”

includes a four-wheeled vehicle that is manufactured primarily for use

on public streets, roads, and highways, and is rated at 6,000 pounds

gross vehicle weight or less. Id. para. (c)(1). A passenger automobile also

includes “any part, component, or other item that is physically attached

to the automobile or is traditionally included in the purchase price of an

automobile.” Id. subpara. (2).

18

[*18] This regulation leads us to conclude that attachments to vehicles

are treated like the vehicles themselves. In Short Stop’s case, the plow

was attached to the forklift. Forklifts are not primarily used on public

streets. That makes a forklift—and any attachment to a forklift—a

“qualified nonpersonal use vehicle” in tax jargon. Id. para. (c). A

“qualified nonpersonal use vehicle” is a vehicle, by reason of its nature

(that is, design), which is not likely to be used more than a de minimis

amount for personal use. Treas. Reg. § 1.274-5(k)(2). The regulations

specifically include forklifts in this exclusion. Id. subdiv. (ii)(K).

The forklift and the plow attachment are not listed property and

are therefore not subject to the heightened substantiation requirement

of section 274.

We now must decide whether the property was predominantly

used for business purposes.

A.

Plow Attachment

We take judicial notice that Minnesota can get a fair bit of snow

in the winter. And we entirely believe Boyum’s testimony about how

Short Stop used the plow attachment—to clear the driveway between

the road and the Boyums’ home, and somewhat beyond that to the Short

Stop headquarters building and warehouse. He’d also sometimes be a

good neighbor and plow the driveway next door. The problem is that we

have no evidence of what proportion of these uses was for the business

and what proportion was for personal use. We think it more likely than

not that Short Stop did not use the plow attachment predominantly for

business uses as the use was not only divided between plowing the

Boyums’ residence and their business, but also their neighbors’

driveway.

We need not determine an exact allocation of personal use and

business expense for the plow in addition to the finding that it was not

used over 50% for business. This is because the Commissioner found

that Short Stop used the plow 50% for business purposes, and allowed

it a depreciation deduction of about half of what it would have been

allowed if it had both not chosen to claim a section 179 deduction and

used the plow only for business. We will disallow the deduction only to

the extent the Commissioner contested it.

19

[*19] B.

Forklift

The forklift is another story. Short Stop used it for a lot of

undoubtedly business uses—to unload trucks, move pallets, and lift

products at worksites. Although a close question, we do think we can

take judicial notice that Minnesota does have lovely seasons that are

snow-free, which means Short Stop was using the forklift entirely or

almost entirely for business for much of that part of the year. It is true

that the only evidence we have on this is Boyum’s testimony, but on this

point we find his testimony credible. Since the forklift is not subject to

the heightened substantiation requirements of section 274(d), we may

estimate an appropriate percentage of business use and allow a

reasonable deduction.

We think it more likely than not that Short Stop used the forklift

predominantly in its business, and we think it is reasonable to find that

Short Stop used it 70% for business purposes. That means that it gets

to expense 70% of the forklift’s cost in 2016. See § 179; Treas. Reg.

§ 1.179-1(d)(1).

IV.

Penalties

That leaves one issue—whether Short Stop owes accuracy-related

penalties under section 6662. The Commissioner determined that Short

Stop both was negligent and substantially understated its tax.

Substantial understatements look easy to prove here. The Code defines

an understatement as substantial if it exceeds the lesser of 10% of the

tax required to be shown on the return or $10 million. § 6662(d)(1)(B).

The deficiency for 2015 was $8,138. This was also the entire tax liability

for the year, which means that 100% of the tax required to be shown was

understated. This is well above the required 10% threshold. 17

Short Stop’s defense is that it relied on advice from tax

professionals when it took its positions on its 2015 and 2016 returns.

Thus, Short Stop needs to show that:

•

its adviser was a competent professional who had sufficient

expertise to justify reliance;

17 The Commissioner does not bear the burden of production as to compliance

with section 6751(b)(1) because Short Stop is a corporation. See NT, Inc. v.

Commissioner, 126 T.C. 191, 195 (2006).

20

[*20]

• it gave the adviser necessary and accurate information; and

•

it actually relied in good faith on the adviser’s advice.

See Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000),

aff’d, 299 F.3d 221 (3d Cir. 2002). Whether a taxpayer relied on advice

and whether his reliance was reasonable turn on the facts and

circumstances of the case. See Treas. Reg. § 1.6664-4(c)(1).

The professional whose advice Short Stop claimed it relied on is

Mike Mischke, a licensed CPA. Mischke has over ten years of experience

in preparing corporate tax returns. No one contests that he is a

competent professional. The problem for Short Stop is the second and

third Neonatology requirements: Did Short Stop give Mischke necessary

and accurate information on some of the items that created its

deficiencies? And did Short Stop rely on that advice?

Mischke credibly testified that he was aware of the loan and

Boyum’s practice of adding unpaid “interest” to the loan principal.

Mischke, however, also credibly stated that he did not advise Short Stop

to take this position, and that Boyum had instructed him that the

allocation and subsequent interest-expense deduction was “the way he

was going to handle it.”

As for the validity of the increased principal and the interest

generated from the purchase of the cabin, Mischke did not recall

receiving a copy of any paperwork describing Short Stop’s purchase of

the interest in the partnership. He did not know whether he saw the

checks and was not sure whether he was even aware that the cabin was

bought with Boyum’s personal checks. We find it more likely than not

that Mischke did not know the vital detail that Boyum was purchasing

the interest in the partnership from his personal account. In any event

Mischke again credibly stated that Short Stop did not ask his advice on

how to record the purchase of the cabin and that he did not advise Short

Stop to record the purchase of the cabin as an increase to the principal

of the shareholder loan. 18

There were similar problems for the section 179 deductions taken

in 2016. Mischke could not remember whether Boyum gave him the

18 Boyum himself testified that he also relied on his previous tax adviser. All

we have on this is Boyum’s own testimony, and we do not find him credible on this

point.

21

[*21] actual invoices for the plow attachment and the forklift, or

whether Boyum had simply given him the accounts and said he’d bought

them for Short Stop. Mischke also testified that he could not remember

whether he was asked for advice about how to report the purchase of the

boat and that he did not know whether he “was smart enough to know

the answer to that.” We find from this that Mischke never gave advice

on the section 179 deductions that Short Stop claimed for 2016.

Therefore, Short Stop has not shown reasonable reliance on the advice

of a tax professional for any of the contested issues.

Without the reliance defense, Short Stop fails to show the

deductions were reasonable and claimed in good faith. See § 6664(c)(1).

A taxpayer acts with reasonable cause when it exercises “ordinary

business care and prudence.” Estate of Young v. Commissioner, 110 T.C.

297, 317 (1998) (citation omitted) (citing United States v. Boyle, 469 U.S.

241, 245 (1985)).

Here, the problem for Short Stop was that an IRS revenue agent

explained during the audit of its 2006 return that claiming interest

deductions by increasing the principal of a shareholder “loan” did not

work. We find that this made it unreasonable for Short Stop to keep

doing what it did in reporting interest paid that it never paid.

As for deducting the boat under section 179, the substantial

personal use of the boat makes its claimed deduction unreasonable.

Though the deductibility of the boat was not contested at trial, we find

that Short Stop could not have reasonably believed that a boat kept at

the cabin at which it threw parties and allowed Boyum’s son to live was

for actual business use.

However, the forklift and the plow attachment were actually used

in part—and in the case of the forklift, mostly—for business. Short Stop

provided no record or allocation, however, of the proportion of business

use for this equipment. The problem for Short Stop here is that we’ve

found it to be a company that has taken unreasonable reporting

positions for a long time, and after being warned not to do so by an IRS

revenue agent. It had a competent adviser but didn’t rely on him for

advice. So, even if other taxpayers might have been reasonable in

deducting the cost of the equipment, Short Stop itself was unreasonable

in not substantiating these deductions. The failure to track and

substantiate in any way their varied uses was not reasonable

22

[*22] here. 19 We therefore find that the accuracy-related penalties apply

for both years at issue.

Short Stop wins a bit on the forklift, so

Decision will be entered under Rule 155.

19 Even though we found that the forklift was used 70% for business, the fact

that Short Stop used the forklift for personal ends and still tried to deduct its entire

cost renders its position unreasonable as to the disallowed part. The nature of a section

179 deduction allows for a deduction of the entire cost of property only if the property

is used solely for business. Had Short Stop claimed a 90% or even a 95% deduction for

the cost of the forklift, we might well have found its estimate of the proportion of

business use to have been reasonable. What we cannot do is find it was reasonable for

Short Stop to claim a deduction for the entire cost of the forklift under section 179

when it knew that the forklift was being used at least in part for personal ends.