Amanda and Paul are equal owners in Talon, Inc., an S corporation, and each has an adjusted basis in the stock of $80,000. In the current year, Talon has a loss of $200,000, and its Schedule K-1s allocate $100,000 to each shareholder.

Amanda and Paul are also equal partners in a partnership. Two years ago, to provide additional working capital to Talon, the partnership loaned it $100,000. The loan bore all of the usual attributes of a bona fide loan (i.e., a formal note, market interest rate, and payment schedule). The loan was recorded as a note receivable by the partnership and as a note payable on the S corporation accounting records. Formal minutes authorizing the loan stated that the partnership was acting as an agent for Amanda and Paul.

Amanda and Paul each deducted their share (i.e., $100,000) of the S corporation loss. They contend that their combined stock basis and debt basis for § 1366(d) purposes is $130,000 ($80,000 + $50,000). The IRS maintains that the basis of each shareholder is only $80,000 (the basis in the stock). The loan cannot count as part of the shareholder's debt basis as it was not made directly to the S corporation. Evaluate the positions of the taxpayers and the IRS.