S Corp Business Bad Debt arising from unrepaid loans to the corp...

[Eva Konigsberg]

S/H lent money to S corp. The company goes out of business before he gets paid back. Business bad debt must be related to the business activity and there must have been a business reason for the debt. Nonbusiness bad debt is any debt that is not a business bad debt — either a personal debt or a debt related to investments.

Regarding Business Bad Debt.... I have read two conflicting things:

1. Let’s say a shareholder-employee made the loan as an employee in order to protect her job. In that case, the loss qualifies as a business bad debt. This entitles her to take an ordinary-loss write-off for the entire amount in the year that she incurs the loss.

2.  From https://thismatter.com/money/tax/bad-debts.htm

For shareholder-employees, classifying the debt as a nonbusiness bad debt is preferable, since it is treated as a short-term capital loss that can be used to offset capital gains and up to $3000 of other income. Any remaining amount can be carried forward indefinitely. On the other hand, a business bad debt for the employee is not deductible. Moreover, the deduction is not allowed for alternative minimum tax purposes.

Which is true?  Is a S/H Employee's business bad debt deductible or non-deductible on the S/H Employee's personal income tax return? 

The IRS says: "You can deduct it on Schedule C (Form 1040), Profit or Loss From Business (Sole Proprietorship) or on your applicable business income tax return."

Does that mean that if the S/H wants to deduct the unrepaid loan on his personal return, he should treat it as a nonbusiness bad loan?

Thank you.

- Eva Konigsberg, EA, MBA

Savvy Tax, Inc.

[psto...@comcast.net]

Eva this is a piece I wrote about this issue some time ago...

Conclusion is. Loans by a SH/employee to their corporation are almost NEVER business... The employee SH has to be in the business of lending money...like a bank...  READ ON: I know Lee has this covered in his BB

"Issue #4 Was the debt “business” or “non-business”  

Business Bad Debt vs. Nonbusiness Bad Debt. Business BD is ordinary loss. Non business BD is deductible as a STCL..(see section 166(d)(1)(B) In the case of taxpayers other than corporations, Section 166(d)(2)… Section 166(d)(2)(A) provides that a business debt is a “debt created or acquired  in connection with a trade or business of the taxpayer” or “a debt the loss from the worthlessness of which is incurred in the taxpayer’s trade or business.” Taxpayers have the burden of proving that a bad debt loss is “proximately related” to the conduct of a trade or business, or that the debt was created in the course of a trade or business. In Cooper v. Commissioner, the Tax Court ruled against the TP, stating  “the right to deduct bad debts as business losses is applicable only to the exceptional situations in which the taxpayer’s activities in making loans have been regarded as so extensive and continuous as to elevate that activity to the status of a separate business.” Factors that courts consider include: the total number of loans made and the time period over which the loans were made; the records kept by the taxpayer of the lending activity; whether the taxpayer’s loan activities were kept separate and apart from the taxpayer’s other activities; whether the taxpayer sought out the lending business; the amount of time and effort expended in the lending activity; the relationship between the taxpayer and his debtors; and whether the taxpayer used normal money-lending methods and practices.”

The TP’s lending activities did not rise to the level of business.. (Read the case for facts that led the Court to that conclusion….)"

Phil

--
You are subscribed to the ClientWhysConnect group.
Post Address: clientwh...@googlegroups.com
Unsubscribe Address: clientwhysconn...@googlegroups.com
For more options, visit this group at
http://groups.google.com/group/clientwhysconnect?hl=en?hl=en
 
Disclaimer --- You use the information shared on ClientWhysConnect.com at your own risk. The information is based upon unsubstantiated member opinions and if you have concerns about the validity of the information you should research the issue thoroughly yourself and arrive at your own conclusions. We will never share any of the information you’ve provided to the ClientWhysConnect.com list with anyone.
---
You received this message because you are subscribed to the Google Groups "ClientWhysConnect" group.
To unsubscribe from this group and stop receiving emails from it, send an email to clientwhysconn...@googlegroups.com.
To view this discussion on the web visit https://groups.google.com/d/msgid/clientwhysconnect/CABWAOpnW%2BHZ1_5tTHXQMtLNpvpWbQgytakYJVenykbwcMnUBdw%40mail.gmail.com.

[Alma Guenther]

My experience is that unless there is a promissory note, IRS will not considered it a loan. I would suggest adjust shareholder basis accordingly.

I am sure others have other stances that they would take. But without a valid note, it is not a business nor personal debt.

Alma V Guenther, EA - The Right Place

817 Missouri St, ste 2 - Fairfield CA 94533

office: 707-425-1865

e-fax: 707-306-7564

cell: 707-331-5378

email: right.p...@gmail.com

--

[psto...@comcast.net]

You are  correct Alma... Bona Fide Debt is a prerequisite for any deduction

Another approach I thought of to get business bad debt was addressed by SCOTUS in  Generes see below...

I remember a case I worked on in the early 1970's ... The TP was a “substantial” SH in White Front (EF) which was a discount department store chain..WF took up bankruptcy & was gone by1974…  This employee/SH made loans & “advances” to White Front.. in magnitudes of hundreds of thousands total millions $$.. Initially, The purpose of these transfers was to save WF from bankruptcy and to save the TP’s investment and as such were Non-business debts… 

These transfers became larger & took on the look of desperation… The “settlement” with the TP was that the early advances were in the form of additional investment and as such were  non-business attempts to save the business (investment) but when the advances became desperate we characterized them as business loans made to WF to save his job as employee of WF and were therefore business…Related to the trade or business of being an employee…

Therefore early loans were characterized as non-business & no deduction was allowed while the later ones were business… This issue was considered in detail by SCOTUS in 1972…

See SCOTUS decision in Generes United States v. Generes, 405 U.S. 93 (1972)…

Excellent read for this issue.. enjoy…

https://caselaw.findlaw.com/us-supreme-court/405/93.html 

So that’s to say that ala Generes your client was trying to preserve his position not as a SH but as an employee… Look for facts to support that the “loans” were made to the S-Corp to preserve his “job” as an employee….. other forum readers need to put into the section 67(g) issue of whether as employee related expenses they are deductible between 2018-2025..TCJA…

Phil