Research Problem 4. Scott and Brooke are the sole shareholders of Tanager Company, a calendar year Subchapter S corporation. After several loss years, in December 2012, Tanager is forced to borrow $300,000 for working capital purposes. Robin State Bank makes the loan to Tanager but only after Scott and Brooke personally guarantee the debt.

Scott and Brooke deduct Tanager’s $200,000 operating loss for 2012 on their individual income tax returns. Although they have a zero basis in their stock investment, they consider the guarantee of the bank loan to be debt within the meaning of § 1366(d)(1)(B).

Are Scott and Brooke correct in their reasoning? Explain.

Partial list of research aids:

Milton T. Raynor, 50 T.C. 762 (1968).

William H. Maloof, 89 TCM 1022, T.C.Memo. 2004–75.