Code §465 limits deductions for taxpayers in business and investment activities to the amount the taxpayer has "at risk" in the venture. Amounts of owners that are contributed to capital are generally at risk. Also at risk are amounts that are borrowed by the venture, and for which the taxpayer is personally liable for repayment or has pledged property as security for repayment.
However, Code §465(b)(4) provides that the taxpayer is NOT at risk for amounts for which the taxpayer is ‘protected against loss through nonrecourse financing, guarantees, stop loss agreements, or other similar arrangements." A recent Chief Counsel Advice explores this limit in context of an LLC owner that guarantees debt of an LLC.
The first issue raised in the CCA was whether the guarantor's rights of indemnification against the LLC borrower protected the guarantor against loss under Code §465(h)(4). That is, under state law, a guarantor who has to pay is entitled to be indemnified for the payment made against the original borrowing party. Here, the Chief Counsel's office recognized that this indemnification right was meaningless since if the LLC did not pay the debt it would be because it had no assets to do so. Therefore, notwithstanding the indemnification right, the guarantor was the 'payer of last resort in the worst-case scenario' since it could not recoup its loss from payment on the guaranty from the LLC obligor.
The second issue was a little different. Here, the guarantor had other co-guarantors. If the lender came after the guarantor and collected the full amount from the guarantor, the guarantor would have rights of contribution from its co-guarantors. Therefore, applying the worst-case scenario, the guarantor would not be on the hook for 100% of the loan amount. Therefore, the guarantor's at risk amount, for purposes of taking deductions, is limited to the amount that the guarantor could not collect from its co-guarantors.
Chief Counsel Advice 201308028
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