Bad Debt Deductions

Deducting bad debt losses can be confusing. You must first establish the loss was from a bona fide loan transaction that went wrong to claim the deduction. Be careful not to make a contribution, or accidental loan, to the capital of a business entity or accept an advance that could be considered an unintended gift.?

To prove the existence of a bona fide debt, you can use the Sixth Circuit’s 11-factor analysis. Some of the more relevant factors are as follows:?

• Documents with loan descriptions look like loans.
• Loans should show a maturity date and repayment schedule.
• A fixed interest rate indicates a loan.?
• Timely fixed-rate interest payments persuasively make the case that shareholder advances are loans.
• Purported loans made by shareholders strictly in proportion to their stock ownership interests indicate equity except when there is only one shareholder.

As an individual taxpayer, you treat non-business bad debt losses as short-term capital losses, which fall under the annual limitation on net capital loss deductions of $3,000 ($1,500 if married, filing separately).?

You may need to wait until the non-business bad debt loss delivers tax savings if you have significant capital loss carryovers from last year’s stock and bond market adding to your loss deductions.

If you want to discuss bad debts or other tax saving strategies, please call us on our direct line at (817)383-0927 or book a complementary strategy session here.

Sincerely,

The Francis and Reeves Advisory Team