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Income Tax Regs., the applicable caselaw, or, indeed, as a matter
of plain common sense, requiring a common shareholder to fund the
S corporation’s losses with funds from his mattress or with funds
borrowed by him from a bank or other unrelated party, rather than
with funds obtained from another controlled entity, in order to
obtain a basis in the unprofitable S corporation to the extent of
the funding.
Recognizing, as he must, that Culnen v. Commissioner, supra
supports petitioners’ position in principle, respondent attempts
to distinguish that case on the ground that, in Culnen, the funds
lent to the unprofitable S corporation were derived from the
after-tax profits of a related corporation, whereas the funds
supplied by Paulan were, in a preliminary step, borrowed from
unrelated banks or, in one instance, from Bavaria, Inc., a
corporation wholly owned by Robert and Lovella. A profitable
entity’s use of undistributed after-tax profits that, in essence,
belong to its controlling shareholders or partners, for advances
to an S corporation in which those same shareholders or partners
are investors, is consistent with the argument that the
profitable entity is acting on their behalf. It is not, however,
indispensable to that argument. Even though Paulan borrowed
money to fund Sidal’s losses, Paulan might still have been acting
on petitioners’ behalf in advancing the borrowed funds to Sidal.
In that connection, we note that, although Paulan did not possess
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