Bad Debt

[HBurkholder]

As usual, TP does their thing and then comes to us to get them out of it. TP's son left wife for neighbor woman. TP's wife feels sorry for ex-daughter-in-law an takes out unsecured loan ($20,000+-) with check made to daughter-in-law for down payment on house. This was intended to be a loan but naturally no note was signed and no mortgage was recorded. Daughter-in-law has not made any payments in 2 years. TP's wife was unable to make payments on loan and settled on debt for less than full amount with money from her retirement acccount resulting in both penalties on early withdrawal as well as being taxed on forgiven debt. She would now like to ease the pain by at least being able to claim bad debt loss. I do not see how I can do this as there is no promissory note and no documentation of collection efforts as well as no event that we can point to (bankrupcy, forclosure, etc). She says she would be willing to forget the whole thing and chalk it up to experience, but her husband is unrelentless in his verbal abuse of her for being so "dumb".
If she would file suit against the daughter-in-law for the debt and obtain an uncollectable judgment against her, would this be sufficient to be able to claim bad debt.

Is this entirely a lost cause or is there something that she can do?

[veritas]

How about suing for repayment? Who knows maybe she could collect something. It would be convincing evidence if there was an audit even if you lost.

I don't know what the cost would be to file a lawsuit.

[jainen]

the old grump

She should sue her grumpy husband--he's the one who is being dumb.

She did a good thing. Maybe it didn't work out in the long run, but I'm sure it was a big help at the time. The fact that it was a personally good thing that she can't get a government tax subsidy for does not in the least diminish her virtue--in fact, it enhances it! Tell the old grump to back off.

[Armando Beaujolais]

TP's wife feels sorry for ex-daughter-in-law an takes out unsecured loan ($20,000+-) with check made to daughter-in-law for down payment on house. This was intended to be a loan

You're firmly on the horns of a dilemma. The payment was either (1) a gift; or (2) a loan.

Your description says it was both. It can't be both.

If the payment was made because the mom felt sorry for the daughter-in-law, it was a gift.

If the payment was intended to be a loan (it would have to have characteristics of an arms-length transaction), it would be a loan.

The intent of the parties is usually what decides the case when it ends up in court.

You generally need to have documented effort to collect the debt to claim a bad debt deduction in the first place. If the client makes the contention that it was a loan, sure, get a judgement. That would nail down "loan." If the client is doesn't want to take legal action, it was a gift.

[OldJack]

Like the husband said.. dumb. Deducting it would be questionable. Not deducting it would be to easy. You have some points to consider in deducting the payoff by the wife.

1) The husband obviously did not make the loan or even know about it so he didn't make a loan or approve a loan to a relative.
2) There appear to be documents obtaining the loan traceable to the x-daughter-in-law receiving the proceeds.
3) The wife did not receive anything and has been required to payoff the loan (her deduction).
4) An x-daughter-in-law is not a relative to the wife especially an x-wife.

With the taxpayer's approval and understanding of any later IRS problems, I would take the deduction as a non-business bad debt. If you do deduct it you should do so in the tax year of payoff.

[veritas]

If my wife took out 20k from her retirement account and I got stuck paying penalties, taxes and having credit problems. All done without my agreement there would be some verbal abuse.

[HBurkholder]

Actually it was ex-step-dauhgter-in-law. It is husband's son's (to a previous marriage) wife. And no, the husband did not know about it at the time. She had documentation sent to her daughter so he wouldn't find out. She says he is one of those folks who won't do anything for anyone.

So if I understand you correctly, you are saying I should ammend return for 2004 and take the deduction?

[veritas]

If you can establish it was meant as a loan and going through with a lawsuit would be fruitless take the deduction.

If you can establish it was a loan and a lawsuit may have merit. File the legal documents and if uncollectable take the deduction.

If you can't establish it was a loan to begin with in some manner then forget it.

What an unfortunate situation the wife created.

[jainen]

two-time loser

>>What an unfortunate situation the wife created.<<

No, she didn't do anything wrong. She was very kind and generous, and that is not "an unfortunate situation."

Unless you mean the unfortunate situation she created by marrying that two-time loser.

[Unregistered]

sounds like a verbal contract

A verbal contract is a legally binding contract, so just because the loan was verbal is not necessarily a problem. However, in order to be enforcable the contract should be in writing. That's the problem. I'd take the position it was a loan if it was a loan and let the IRS dispute it if they like.

[Armando Beaujolais]

A verbal contract is a legally binding contract, so just because the loan was verbal is not necessarily a problem. However, in order to be enforcable the contract should be in writing. That's the problem. I'd take the position it was a loan if it was a loan and let the IRS dispute it if they like.

Sure, a verbal contract is great. Assuming that both parties agree 100% to what was said verbally, which has about a 0% chance of happening in a situation like this.

If it was a bona fide loan, there would be collection action. If the client doesn't want to take collection action, I can't see any better proof that the transaction was not a loan. The IRS will ask for evidence that collection action was taken.

To be honest, if everybody's sitting around wondering whether this was a gift or a loan, it was a gift. If it was a bona fide loan from the start, there would be no question that it was a loan.

"Actually it was ex-step-dauhgter-in-law. It is husband's son's (to a previous marriage) wife"

I saw this episode on Jerry Springer. The audience voted "gift."

[Unregistered]

To be honest, if everybody's sitting around wondering whether this was a gift or a loan, it was a gift. If it was a bona fide loan from the start, there would be no question that it was a loan.

Would you believe that someone (of the class of wife's financial) would borrow money to make a gift of $20,000? As Spock would say "not logical". Its a loan deductible when wife made payment on the loan.

[Uncle Sam]

Bad Debt

From what was described in the original and subsequent posts - wife not informing husband, sharing info with ex-step in law and not husband, it appears on the surface it's a GIFT, not a loan.
It appears the action was taken to financially support the offended spouse in defense of step son's actions.
I vote GIFT, not loan. No tax recovery.

[taxmandan]

It's a gift

I say it's a gift, and my wife would be grumpy and verbal abusive too if I hid financial stunts like this from her. A loan/gift to an ex-step-daughter-in-law? Sheesh, maybe the tooth fairy will stop by and make everything OK.

[jainen]

Sheesh

Sheesh, there's even verbal abuse coming from the total strangers on this forum! I say it was noble of her to embrace her new husband's old family, especially in the face of such infidelity, blame game, and unloving behavior.

She spent her own money according to her own wishes, and I don't see a single thing wrong with that. (I also don't see a tax deduction with that.)