Bad debt?

[Possi]

My client loaned a man $2000.00, 2006. He got paid $100.00 in 06 and $100 in 17. When he tried to collect the balance, he was threatened and spat upon. He is not going to receive the balance.

We are taking the loss as s/t on Sch D as instructions state. (Non business bad debt)

The instructions also say that I need to attach a statement to the return. I didn't know that, until I read the entire instruction. Can I not e-file this return?

I did a bad debt on Sch D many yrs ago when I was at tax-in-a-box and simply entered "bad debt" and let it rip. I don't think it came back at us...

Just whining, I know.....but I really wanted to e-file this friggin return.

[S T]

Notes

My Tax Software allows me to add notes, so that I can still efile.
Doesn't appear that form 8453 will work, as I don't think you can check any of the boxes listed.

Sandy

[Zee]

Here's an explanation I found with a quick web search:

How to write off a personal bad debt on the tax return

"If the debt had no connection to business activity or purpose, then it would be considered a personal bad debt. Usually this is a result of making a loan to a friend or relative who fails to repay the loan. This type of bad debt is considered a short-term capital loss and is claimed on Schedule D of the Form 1040. As such, it will first be matched with the capital gains on the Schedule D. Any remaining loss after matching against capital gains will then flow from the Schedule D to the front of the Form 1040, with a limit of $3000.00 per year ($1500.00 for married filing separately) in deductible capital losses. The balance will be carried forward to future years and reported as a carryforward on the next year's Schedule D.

Personal bad debts must be carefully documented and this is especially important if the bad debt was to a relative. Under audit, the IRS will request a copy of the promissory note or other proof that the loan was really a loan and not intended to be a gift.

For both personal and business bad debts, but again especially for personal bad debts (and add emphasis to that if the loan is to a relative), it is crucial to have careful documentation on your efforts to collect the debt. Normally this includes copies of demand letters and other collection correspondence. It would also include the services of an attorney or filing a collection lawsuit. If you make no effort to collect a personal bad debt, then in general you may not write it off the bad debt on your tax return.

I wouldn't file this return without asking more questions about how he tried to collect this debt and the documentation supporting it.

If a note must be attached, I'm not sure whether you can efile or not. I'll try to find out and add to this post. Drake software also allows notes, but I don't know if they're included in the transmission.

[Possi]

I'm going to file it...

I'm going to tell the client what is required in case of an audit, and file the return. He has tried for 2 years to collect this debt and was finally spat on and threatened. I'll document all that I can, and do a paper return unless you find that I can e-file it.

Taxwise allows Tax Preparer notes, but I feel confident that the notes do not get filed with the return.

Thanks for the documentation and opinion. I'll be sure he understands all the ramifications.

By the way, twice I have refused to do bad debt to two different women who paid contractors CASH to do work they didn't complete. This guy has the canceled check and other information, so I'm going to take my chances. The women didn' t have any documentation whatsoever.

Thanks again, and I will check back to see if you found that I can e-file it.

Gracias!
~possi

[erchess]

Some things to think about

First of all we all know that you can never deduct a bad debt unless you can prove that a debt exists. It is not enough to prove that you gave someone money. There must be proof (usually in the form of a written contract) that at the time you gave someone money you and they agreed that they were going to repay the money. I have read that your client can prove he gave the money but not that he can prove that there was an understanding that it was to be paid back.

The second thing we know is that you cannot deduct a bad debt until all possible means of recovery have been tried. In my opinion this means at the very least that we have sought help from an attorney or a collection agency or both. No amount of personally asking that the debt be repaid suffices. I didn't read much detail but I formed the idea that your client has not consulted an attorney or a collection agency.

The third thing we all know is that sometimes it is our unpleasant task to tell a client or potential client that they cannot write off an expense. It does not matter how much we like or sympathize with the client or think that the applicable laws are unjust. If we let a client claim a deduction when we know or should know that he can't we risk preparer penalties and we make life more difficult for other Tax Professionals.

I'm sorry to be so blunt. Let me take the opportunity to say that I have a high opinion of Possi's competence and professional integrity and I am sure that unless I am very much misunderstanding the facts, she will not let this client claim his alleged bad debt at this time.

[oceanlovin'ea]

Bad debt

I have written off bad debts for people in the past.I had a client who was a very generous person and he would loan people money and sometimes they would pay hm back and sometimes they wouldn't. His wife got very upset with him.
But we fnally convinced him that he had to get a written agreement with the people at the time he loaned them the money. This proved to the people that he was serious about being repaid and it established a basis for tax purposes if they did not pay.
He made attempts to collect the money when they didn't pay him. Sometimes they moved away, sometimes they were out of work and had nothing to pay with and just told him they were sorry but they couldn't pay him any more of the money.
I never made him go to court to prove collection attempts, but he did keep record of his attempts and sent certified letters to them.

This was way in the past when I was a H&R Block that this happened. Usually with most programs you can add a statement to go with a return. I would type out a statement and tell what proof he had and what attempts to collect he had made. I never had any of them questioned.

Linda

[Zee]

I haven't found anything indicating whether you can e-file a return with a note, or not. Perhaps someone else can help.

[Davc]

If a note must be attached, I'm not sure whether you can efile or not. I'll try to find out and add to this post. Drake software also allows notes, but I don't know if they're included in the transmission.

Notes go in Drake if you use the SCH screen.

[Zee]

Notes go in Drake if you use the SCH screen.

Yes, that's correct. I think I used the SCH screen for an NOL note. But, are they transmitted with the e-file?

[David1980]

Bad debts are one of those things that depend upon whether there's an audit and how generous the auditor is. My guess is by far the majority of non-business bad debt deducted probably doesn't even have a contract written. If it's not audited it doesn't matter - then again you could say the same for any fictitious deduction. If it is audited those kinds of things can create preparer penalties.

If it is audited, it depends on the auditor as to whether or not it'll be allowed. I think without a written contract unless it's an insignificant amount it will be disallowed. I could see auditors having different requirements for the collection attempts. Whether they require a court judgement or not probably depends on the auditor.

Personally, the safest approach is to probably file in small claims court, if the debt is within the limits. If it's beyond those limits, I sure hope they consulted an attorney before making that loan. I haven't prepared many bad debts myself - had lots of people want to claim them, but it's almost always a verbal agreement between friends & family and that doesn't stand much chance of being a realistic deduction.

[AuditorTurnedGood]

I did a few of these

when I was auditing. All of them: No promissory note, not interest rate or repayment schedule = not a bonafide debt = no deduction.

[erchess]

Yes

Yes, that's correct. I think I used the SCH screen for an NOL note. But, are they transmitted with the e-file?

Yes in Drake if you write a note with the SCH Screen it goes to the taxing agencies. Every software package I have ever used had a way to write notes that went with the return and notes that did not go with the return.

[Possi]

I hear you...

He is a man of very little means. He wouldn't be able to take it to court. I have been to his house and see his living conditions... handicapped wife, grandchildren and great grandchildren he is supporting, broken down cars everywhere... I don't know how he got $1000 together to make the loan to begin with...

But I am seeing on the board that I can't do a tax return based on my sympathy.

And I sure don't want to risk preparer penalties.

Thanks everyone.

I'm sad now, but I'll put on my big-girl-panties and deal with it professionally.

[Gene V]

Possi,
Your story is changing-first the guy loan $2,000-now only $1,000
Not that it matters—from your last story, looks like he wouldn’t owe
any taxes anyway, with his low income and grandkids as dependent,
He may not need the bad debt loss.
IMHO
Gene

[Possi]

not claiming his grandchildren

Possi,
Your story is changing-first the guy loan $2,000-now only $1,000
Not that it matters—from your last story, looks like he wouldn’t owe
any taxes anyway, with his low income and grandkids as dependent,
He may not need the bad debt loss.
IMHO
Gene

His granddaughter claimed her own child and got EIC. Not as HOH, but single FS. He isn't legally married to his handicapped partner who gets alimony and SS, so he can't claim her either.

You are right, his tax bill isn't very bad, relatively speaking. (It was not 2000 but 1000, my mistake) It's only $120.00 difference. That's not anything to you or me, but to him it is. Certainly not worth my risking my own integrity in an audit, indeed.