Non-business bad debt


C

CBotella

A client loaned her son some money for his business. He
signed a note for herwhen she lent him the money.
Subsequently he lost the business, owes the IRS for payroll
and business taxes, is broke, was on drugs, went into rehab,
and has recently had surgery.

There does not seem to be any chance of collecting her money
from son. Can she write this off as a non-business bad
debt, or does she need more proof that the money is really
uncollectable?

Kate, EA in PA
 
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D

David Woods, EA, ChFC, CLU

CBotella said:
A client loaned her son some money for his business. He
signed a note for herwhen she lent him the money.
Subsequently he lost the business, owes the IRS for payroll
and business taxes, is broke, was on drugs, went into rehab,
and has recently had surgery.

There does not seem to be any chance of collecting her money
from son. Can she write this off as a non-business bad
debt, or does she need more proof that the money is really
uncollectable?
Sounds uncollectable to me.
 
A

A

CBotella said:
A client loaned her son some money for his business. He
signed a note for herwhen she lent him the money.
Subsequently he lost the business, owes the IRS for payroll
and business taxes, is broke, was on drugs, went into rehab,
and has recently had surgery.

There does not seem to be any chance of collecting her money
from son. Can she write this off as a non-business bad
debt, or does she need more proof that the money is really
uncollectable?
Under Reg 1.166 worthlessness is a determination of fact
determined from all the evidence, including the value of any
collateral and the financial condition of the debtor. The
bigger problem is showing that it was really a debt. Because
transactions between relatives are presumed gifts the
existence of a note may not be enough to show it was a bona
fide loan. Since the "loan" was to start a business she may
also have to show that the business had a reasonable chance
of success... which given the facts so far may be difficult.
(i.e. if the son has no business experience, had an existing
drug problem, etc. did the business really have a chance to
succeed?)
 
E

Ed Durall

There is a very clear description of how to handle this in
Pub 17.
 
C

Christopher Green

A client loaned her son some money for his business. He
signed a note for herwhen she lent him the money.
Subsequently he lost the business, owes the IRS for payroll
and business taxes, is broke, was on drugs, went into rehab,
and has recently had surgery.

There does not seem to be any chance of collecting her money
from son. Can she write this off as a non-business bad
debt, or does she need more proof that the money is really
uncollectable?
Non-business bad debts are looked at closely, because the
potential for abuse (converting a taxable gift into a
deductible bad loan) within a family is great. Buchanan and
Buchanan v. United States (1996, online at
http://www.law.emory.edu/7circuit/june96/96-2220.html) does
take up the issue of when a non-business bad debt becomes
worthless and thus deductible.

The Seventh Circuit took the position that a non-business
bad debt is worthless when it is plain that no more than the
cost of collection or a penny or two on the dollar is
recoverable, or when the only hope of collection is that the
debtor receive an unforeseeable windfall such as winning the
lottery. Relevant to your question, it also emphasized that
the absence of serious effort to collect a debt, such as
suing the debtor for it, casts doubt on the worthlessness of
the debt (or on the loan character of the transaction).

Other commentators say pretty much the same thing, e.g.
"Rewards and risks in lending to your child - business
loans" (Nation's Business, March 1998, online at
http://www.findarticles.com/p/articles/mi_m1154/is_n3_v86/ai_20401411):
if you don't make a serious effort to collect, the
so-called bad debt is really a gift.
 
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G

GenFinSvcs

A client loaned her son some money for his business. He
signed a note for her when she lent him the money.
Subsequently he lost the business, owes the IRS for payroll
and business taxes, is broke, was on drugs, went into rehab,
and has recently had surgery.

There does not seem to be any chance of collecting her money
from son. Can she write this off as a non-business bad
debt, or does she need more proof that the money is really
uncollectable?
In my opinion, the stock answer would still apply. What
collection attempts have there been in comparison to the
facts and circumstances presented and the balance due on the
note? While I think it appears to be uncollectable, I would
cover my bases to the extent the amount of the loan
represents.

Mike
 
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