## Facts

- Dennis E. Bolding was the sole shareholder and president of Three Forks Land & Cattle Co., a Texas Subchapter S corporation engaged in cattle operations.
- Before 1990, Bolding advanced roughly $500,000 to Three Forks; the advances were recorded as shareholder loans, but no promissory notes were executed.
- In 1990, Bolding and his accountant concluded Three Forks could not repay those advances; the prior “loan” balance was contributed to the corporation as capital.
- In 1990, Bolding needed additional funds to stock a leased ranch and obtained a bank line of credit.
- The bank required only Bolding’s personal financial information; Bolding signed the note and related documents in his individual capacity.
- The borrowing was secured by livestock used in the ranching operation carried on through Three Forks.
- The line of credit later went into default, and the bank sued Bolding personally.
- The Boldings claimed pass-through S-corporation losses on their individual return; the Commissioner disallowed losses exceeding Bolding’s basis, asserting the bank debt did not create S-corporation “debt basis.”

## Issues

1. Whether a shareholder’s personal borrowing used to finance an S corporation’s operations can constitute “indebtedness of the S corporation to the shareholder” under I.R.C. § 1366(d)(1)(B), thereby increasing the shareholder’s basis to deduct pass-through losses.

## Decision

- The Fifth Circuit reversed the Tax Court.
- The court held that, on the record, the indebtedness was treated in substance as running between Three Forks and Bolding, creating shareholder debt basis under § 1366(d).
- The court remanded for recomputation of allowable losses consistent with recognition of debt basis.

## Legal Principles

- Under I.R.C. § 1366(d)(1), an S-corporation shareholder’s loss deductions are limited to stock basis plus the shareholder’s basis in bona fide indebtedness of the corporation to the shareholder.
- The basis inquiry focuses on economic reality: whether the shareholder made an actual economic outlay and was ultimately at risk, and whether the arrangement functioned as a genuine debtor-creditor relationship between the corporation and shareholder.
- Formal loan documentation running only between the shareholder and a third-party lender does not necessarily bar debt basis if the transaction’s substance is equivalent to a back-to-back loan for corporate use with an expectation of corporate reimbursement.

## Conclusion

The Fifth Circuit required a substance-based analysis of S-corporation debt basis and held that Bolding’s personally incurred bank debt, used for the corporation’s ranching business with Bolding bearing the ultimate risk, could be treated as bona fide corporate indebtedness to him for purposes of § 1366(d) loss limitations.


Bolding v. Comm’r, 117 F.3d 270 (5th Cir. 1997)