Peracchi v. Commissioner

United States Court of Appeals for the Ninth Circuit · 1998 · Corporations

CorporationsTaxSection 351Section 357(c)Shareholder capital contributionsBasisI.R.C. § 351I.R.C. § 357(a)

Facts

Peracchi needed to contribute additional capital to his closely held corporation, NAC, so it could comply with Nevada's minimum premium-to-asset ratio for insurance companies. He contributed two parcels of real property, but the liabilities on those parcels exceeded his basis in them by $566,807, which would ordinarily trigger gain under section 357(c). To avoid that result, he also contributed a ten-year promissory note for $1,060,000 at 11% interest and argued that the note had basis equal to its face amount. The IRS contended that the note was either not genuine indebtedness or, even if genuine, had zero basis in his hands.

Issue

Whether a shareholder's promissory note contributed to his wholly owned corporation has basis in the shareholder's hands for purposes of section 357(c), and whether Peracchi's note was genuine indebtedness rather than a sham or gift. More specifically, the question was whether the note's face amount could be counted in aggregate basis so that liabilities would no longer exceed basis.

Rule

For purposes of section 357(c), a shareholder who contributes a valid, unconditional, recourse promissory note to an operating C corporation subject to a non-trivial risk of bankruptcy or receivership has basis in the note equal to its face value, so long as the note is in fact worth approximately that amount and has real economic effect by increasing the shareholder's personal exposure to corporate creditors. A note that is ordinary, negotiable, transferable, enforceable by third parties, bears a market rate of interest, has a fixed term, and is backed by a creditworthy obligor is genuine debt for tax purposes.

🔒

See the holding & full analysis

Create a free KwikCourt account to unlock the rest of this brief — and practice the case.

The court's holding and reasoning
Doctrine tests, pitfalls & exam hypotheticals
10 practice questions + 4 AI-graded essays on this case

Free sample · practice this case

Test yourself

One of 10 multiple-choice questions for this case. Pick an answer to see why.

In Phoenix, Elena Ruiz transferred two apartment buildings to Solterra Casualty, a wholly owned C corporation that actively underwrites regional insurance policies. The buildings were subject to liabilities exceeding Elena's aggregate basis by $400,000, so she also contributed her 8-year recourse promissory note for $500,000 bearing a market interest rate; Elena is solvent, and the note is transferable and enforceable by creditors if the corporation fails.

For purposes of determining whether liabilities exceed basis under section 357(c), how should the note most likely be treated?

Explanation. The majority held that, in the C corporation context, a shareholder's valid, unconditional, recourse note may have basis equal to its face value for section 357(c) if it is worth approximately that amount and has real economic effect by increasing the shareholder's exposure to corporate creditors. Here, the corporation is an operating C corporation with bankruptcy risk, Elena is creditworthy, and the note is enforceable and transferable, so its face amount is included in aggregate basis.