C-Corp. Non Business Bad Debt-Why write it off?

[DMICPA]

C-Corp. client lent a person $5,000. C-Corp. is not in the business of lending money but this was a guy the owner knew and tried to help him out.

Guess what, Guy cannot repay the $5,000. What a surprise!

I am getting ready to do the Corporate taxes and a C-Corp. cannot deduct this loss unless it has unused gains (Capital gains). So there is no tax benefit from writing this off the books. This is a Form 8949 and schedule issue so it falls into the Corporate capital loss rules.


Why write it off at all? Why not just leave it as a loan receivable? What advantage is there to write it off?


?:

[mastertaxguy]

When is the loan uncollectable?

1. Determine if the loan is really uncollectable: has the statute of limitations run? Did the debtor file bankruptcy, etc.
2. It may be possible to have an "uncollectable" date down the road when, perhaps, there will be some capital gains which can be offset in whole or in part.

3. If the Corp is writing off the loan, a 1099-C should be issued.

[DMICPA]

1099-C not required in this case

According to the instructions of the 1099-C a form would not be required.

The Corporation would be better off leaving the receivable on the books if there is no tax benefit.

[TXEA]

Generally a bad debt deduction is allowed when their is no prospect that the loan or receivable will be collected (i.e., when it is worthless). It is in this year when the deduction is allowed.

Finally, in general, a corporation does not have non-business bad debts. The loan can probably be taken as an ordinary business deduction. Here is an excerpt from Pub 535 Section 10

"A debt is closely related to your trade or business if your primary motive for incurring the debt is business related. Bad debts of a corporation (other than an S corporation) are always business bad debts."

Here is Reg 1.655(a)(2) -
§ 1.166-5 Nonbusiness debts.
(a) Allowance of deduction as capital loss.
(1) The loss resulting from any nonbusiness debt's becoming partially or wholly worthless within the taxable year shall not be allowed as a deduction under either section 166(a) or section 166(c) in determining the taxable income of a taxpayer other than a corporation. See section 166(d)(1)(A).
(2) If, in the case of a taxpayer other than a corporation, a nonbusiness debt becomes wholly worthless within the taxable year, the loss resulting therefrom shall be treated as a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 1 year (6 months for taxable years beginning before 1977; 9 months for taxable years beginning in 1977). Such a loss is subject to the limitations provided in section 1211, relating to the limitation on capital losses, and section 1212, relating to the capital loss carryover, and in the regulations under those sections. A loss on a nonbusiness debt shall be treated as sustained only if and when the debt has become totally worthless, and no deduction shall be allowed for a nonbusiness debt which is recoverable in part during the taxable year.

(2) seems to be saying that everyone other than a corp gets capital loss treatment.

[DMICPA]

Txea

This Corporation did not have a business purpose in this loan. It was a needy friend of the owner, so yes, a cash basis Corporation can have a bad debt, it is treated as a capital item on 8949 going to Schedule D.

I have suggested that the friend do some work for the Corporation and we could issue a 1099-MISC but the debtor doesn't want to have any taxable from this.

I will have another conversation with the Corporation owner to see what he wants to do.

Thanks.

[JohnH]

Maybe you should mention to the client that his corporation paid tax on the money it loaned to the friend. The corporation had to earn the money in order to have it on hand in the first place, and a loan is simply moving the amount from one asset account to another on the balance sheet, so thus there is no tax deduction and in effect the corporation has paid tax on the loan.

Don't know if that matters to him in the total scheme of things, and he still may not want the borrower to have to pay tax on it, but he needs to know the facts.

[TXEA]

Dmicpa

Not disputing the bad debt......

Just saying the bad debt does not appear to be a capital loss.....it appears to be an ordinary bad debt deduction.

It is a business bad debt deduction if it is deduction at all. Corporations can not make personal loans (only an individual). So, the only other argument is that this a disguised dividend to the owner of the corporation to a needy friend and no deduction at all for the corp.

Looking at this another way, everything a corporation does is business. If payments are disbursed from a corp not related to business, then it is a dividend or loan to the officers/owners.


Please look again at the reg I posted and the non-authorative quote from the publication. The Reg says for all other than corporations.....The word always in the Publication seems fairly straightforward when read with the Regulation.


I am unable to find anything authoritative that states that a corporation can have a non-business bad debt. It is either a disguised dividend to the owner or a business bad debt (front page 1120) IMHO.

If there is no loan agreement or other formalities then it can be further problematic for anyone to take a deduction.

Would welcome other input as this is not as easy of an issue as it appears.

[DMICPA]

Hmmm

I read Pub 535 and it said if there was any business relationship, (client, supplier, employee), the Corporation can consider this a business bad debt.


Per the Pub:
Loans to clients and suppliers. If you loan money to a client, supplier, employee, or distributor for a business reason and you are unable to collect the loan after attempting to do so, you have a business bad debt.



However, the line on page 1 of the Corporate 1120 for Bad Debts has this:

You can claim a business bad debt deduction only if the amount owed to you was previously included in gross income. This applies to amounts owed to you from all sources of taxable income, including sales, services, rents, and interest.


Sooooo, the next phase would be where to deduct this bad debt. I am thinking in the other deductions section.


Nevertheless, it should go somewhere. Placement may not be as important as facts and circumstances.

[JohnH]

So, is there any sort of business relationship between the Corp and the borrower?
If so, then perhaps you have a business bad debt.

I've always interpreted the instructions regarding Bad Debt entries on Page 1 of the 1120 to be applicable to cash basis taxpayers who try to write off unpaid debts when they never accrued the income in the first place. Thus, a corporation which enters a figure on that line but checks the "Cash Basis" box under Accounting Method has set a trap for themselves.

I'd be inclined to list it in "Other Deductions" as well, provided I was comfortable with the "business relationship" test.

On the other hand, if there is no possibility of there being a business relationship, then TXEA brings up an interesting point. If the owner of the corp just loaned money from his company to a fishing buddy, not only is it non-deductible by the corp but it might also be a "Constructive Dividend." The corp has already paid tax on the loan (by virtue of the fact that it could not take a tax deduction), and the constructive dividend also becomes taxable income to the owner. But then if he can show that he took sufficient steps to collect the debt, he can then deduct it as a non-business bad debt. That will eventually wipe out the personal tax on the dividend, but it does nothing to reverse the corp income tax paid on it in the first place.

This is the sort of thing that happens when clients look at the money in their corporations as monopoly money. Fortunately, he only has about $1K - $2K in taxes at risk in this $5K transaction (depending upon what state you are in). Maybe he will have learned his lesson before he loans somebody $50K and has some real difficult tax issues to deal with.

[TXEA]

Good point on the Bad Debt line of Form 1120 - from the instructions.

I would think other deductions is the only place this can go assuming it was a bona fide debt and you as the preparer are satisfied that there exist enough formalities to document the debt and reasonable expectation of repayment.

I would make certain to protect myself that there is a reasonable paper trail to document the debt (loan agreement, stated interest, collateral maybe, repayment schedule, etc) so as to not have to fight the argument that this was in essence a disguised dividend to the owner of the C-Corp.

Good Discussion.

[Roland Slugg]

For a corporation there is no such thing as a "non-business bad debt" giving rise to a STCL. A corporation's bad debts are always business bad debts. Deduct it on the "bad debts" line on F-1120. That's what the line is there for.

[buzzardbreath]

Amazing

If the recipient of this "loan" were a related taxpayer, or related to a 50% owner, then the complexion changes. It could very well be considered as a dividend if the owner does not pay it back.

Not only does the recipient not going to pay the money back, he doesn't want a 1099. It's hard to try to answer the original question without some thinking of morals, and denying a deduction of any sort. I don't believe the owner who was responsible for the corporation "loaning" the money should benefit except on a personal level via a non-business bad debt. Charging him with dividends would give him basis in the loan. The corporation has no business purpose in the loan, especially if the loan bears no interest.

You can almost predict the outcome from the very beginning. Guy walks in and if he weren't already someone the banks have given up on he wouldn't be showing up to begin with. I'm sure he had very pressing reasons for needing the money but I've never known distressing lifestyles to be improved by throwing free money at them.

Of course tax laws are not governed by morals or what me or anyone thinks is right and wrong, but instead by statutory law.

[JohnH]

Yes, the circumstances surrounding the loan are probably very interesting, and the outcome somewhat predictable.

I suspect the owner knew that at the outset, which may be why he made the loan with his company's presumed "monopoly money" rather than cash out of his personal checking account. Even some otherwise fairly savvy business owners make an illogical leap when they fall into the trap of thinking the company money is somehow different from the money in their personal accounts. How many times have we hear clients say "I'll just let the company pay for it." They need to learn to think in terms of asset increase & decreases rather than the particular buckets the cash is sitting in at any given time. And for a 100% owner, a decrease of $5K in his corporation's value is ultimately a decrease of $5K in his personal net worth.

But back to the lending decision.
The basic rule should be "If the bank doesn't want to loan you money, why in the world would I?"

[dodgedipduck]

To be a business bad debt, there must be a true debtor-creditor relationship, there must be a real expectation of repayment, and there must be a real business purpose. Taking the money out of the corporation's account isn't a Get Out of Jail Free card. Likewise, someone being a supplier, employee, etc., doesn't automatically change the nature of the transaction.

I haven't seen anything in the description of facts to indicate any business purpose. It sounds like the owner felt personally sorry for somebody, and took cash from the corporation's account to try to "help." Personal transactions conducted through a corporation's bank account are reclassified all the time by the IRS. Just because the money came out of the corporate account does not magically transform the transaction from personal to business.

IMO, from the info stated, the only transactions that would be appropriate (and legal) would be booking the amount as an owner's withdrawal of capital and a subsequent gift to a needy person. This had nothing to do with business, and wouldn't even fly as a personal bad debt if the reason was because the owner felt sorry for the guy.