An individual was at risk for half a loan even though he was unlikely to have to pay on his guarantee of the loan and may not have been able to do so.

Michael Moreno used a limited liability company he owned to buy a Learjet for $7.9 million. The LLC borrowed the full purchase price from GE Capital. Both Moreno and another company with substantial assets of which Moreno owned 98% guaranteed repayment of the loan. It appears that the LLC was a disregarded entity for tax purposes.

Moreno claimed $4.775 million in depreciation on the jet in the year the LLC bought it. The IRS disallowed the amount because it said Moreno was not at risk for the purchase price. Individuals, S corporations and closely-held C corporations, meaning corporations in which five or fewer shareholders own more than half the stock, can claim losses only to the extent such taxpayers are at risk. Ordinarily, the fact that an individual personally guaranteed repayment of a loan used to pay the purchase price means the individual is at risk.

The IRS said the guarantee in this case was illusory.

It pointed to internal GE Capital memos showing that GE Capital looked solely to the other, corporate guarantor and did not mention Moreno as a possible source of repayment when evaluating whether to make the loan. The IRS also said Moreno had only $11,537 in liquid assets at the time. Moreno said he had a net worth of $27 million consisting largely of shares in another company. Finally, the IRS said that because Moreno owned 98% of the corporation that was the other guarantor, he would make sure it paid on its guarantee before he had to do so.

A federal district court in Louisiana held in late May for Moreno. It said the government cited no legal authority that a guarantor must have liquid assets to support its guarantee. Liquidity of assets is not the test. It said the government also cited no authority for its proposition that where there are two sureties, and the evidence shows the lender was looking only to one, the guarantee of the other is ignored.

The court treated Moreno as at risk for half the loan because of cross indemnities requiring each guarantor to reimburse the other if there is a claim. The case is Moreno v. United States.

by Keith Martin