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In his brief, respondent heads one of his arguments that
petitioner did not have sufficient basis in his Wedgewood
investment as follows:
The fact that all payments to Wedgewood Associates,
Inc. came directly from Culnen and Hamilton, precludes
petitioner from claiming those amounts as his basis in
Wedgewood and thus, the Schedule E losses. [Emphasis
added.]
If respondent is suggesting that the question of whether Culnen &
Hamilton lent those amounts to petitioner is irrelevant since, as
a matter of law, direct payments by Culnen & Hamilton to
Wedgewood establish Culnen & Hamilton’s status as the investor in
Wedgewood, he is wrong. In Hitchins v. Commissioner, 103 T.C.
711 (1994), in explaining the statutory requirement that the
indebtedness of the S corporation must run directly to the
shareholder, we made it clear that an indebtedness to an entity
with passthrough characteristics that has advanced the funds to
the S corporation and is closely related to the taxpayer does not
satisfy the statutory requirement. See id. at 715. We did not
say, however, that the fact that the borrowed funds originate
with the closely related entity precludes the indebtedness of the
S corporation from running directly to the shareholder.
Certainly, where there is a close relationship among the
S corporation, the taxpayer, and the related entity, we will
scrutinize the relationships established with respect to the
transfer of funds to ensure that those relationships comport with
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