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MequonCPA, Certified Public Accountant (CPA)
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Experience:  CPA, Over 30 yrs experience w/individuals and small businesses. Masters in Tax.
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civil judgement and interest for business tax deductible

Resolved Question:

I had a business in the early 90''s. there was a judgement for about 200k in the mid 1990''s against me which I did not fight. this judgement includes expenses for the business that I signed promissory notes for. fast foward 10 years, the person is trying to collect on the judgement. If I pay the judgement, is it tax deductible?
Submitted: 6 years ago.
Category: Tax
Expert:  MequonCPA replied 6 years ago.

DearCustomer-

Depending on your relationship with the business, your payment of the debt will either be a personal bad debt or a business bad debt. A personal bad debt is deductible as a short term capital loss. A business bad debt is deductible as an ordinary loss.

Below is an excerpt from IRS Publication 535 Business Expenses and a link to the publication itself.

Business loan guarantee. If you guarantee a debt that subsequently becomes worthless, the debt can qualify as a business bad debt if all the following requirements are met.

  • You made the guarantee in the course of your trade or business.

  • You have a legal duty to pay the debt.

  • You made the guarantee before the debt became worthless. You meet this requirement if you reasonably expected you would not have to pay the debt without full reimbursement from the issuer.

  • You receive reasonable consideration for making the guarantee. You meet this requirement if you made the guarantee in accord with normal business practice or for a good faith business purpose.

Example.

Jane Zayne owns the Zayne Dress Company. She guaranteed payment of a $20,000 note for Elegant Fashions, a dress outlet that is not a "related person." Elegant Fashions is one of Zayne's largest clients. Elegant Fashions later defaulted on the loan. As a result, Ms. Zayne paid the remaining balance of the loan in full to the bank.

She can claim a business bad debt deduction only for the amount she paid, since her guarantee was made in the course of her trade or business for a good faith business purpose. She was motivated by the desire to retain one of her better clients and keep a sales outlet.

Deductible in the year paid. If you make a payment on a loan you guaranteed, you can deduct it in the year paid, unless you have rights against the borrower.

Rights against a borrower. When you make payment on a loan you guaranteed, you may have the right to take the place of the lender. The debt is then owed to you. If you have this right, or some other right to demand payment from the borrower, you cannot claim a bad debt deduction until these rights become partly or totally worthless.

http://www.irs.gov/pub/irs-pdf/p535.pdf

 

MequonCPA, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 2325
Experience: CPA, Over 30 yrs experience w/individuals and small businesses. Masters in Tax.
MequonCPA and 2 other Tax Specialists are ready to help you
Customer: replied 6 years ago.
this is very helpful, but I am still not 100% sure it qualifies as a business bad debt. Here are the details:

I sign an agreement for a software license. the first payment was 100k. I signed a note for the 100k with my investor and made the payment. I am now faced with paying my own debt, which was during the normal course of busines (one sole proprietership and one corporation), which was supposed to be paid back by the corporation, when it made money, which it did not.

business or personal?

Also, what about the interest on the judgement? the judgement is 200k and the interest 10 years later is another 200k?

thanks
Expert:  MequonCPA replied 6 years ago.

Dear green... -

I want to understand the situation:

2 licensing agreements, one w/sole proprietorship one with corp?

C Corp or S Corp?

Did you own the corp 50/50 with the investor.

Investor paid for the agreement, corp & individual sign note to repay investor. Individual guarantees corporate debt.

Customer: replied 6 years ago.
Reply to Steve's Post: yes. as sole pri I did the license with 3rd party software firm. then assigned the license rights to the corp after making the first payment (which turned out to be a loan to me, not an investment by my "partner"). I owned 51% of the corp for a while and then sold my shares to the "partner" when things fell apart.

He filed the suit 3.5 years later and then never came after the money. now he is.
Expert:  MequonCPA replied 6 years ago.

DearCustomer-

Did you sole proprietorship write off any of the licensing agreement.

Was it a C Corporation or an S Corporation.

 

Customer: replied 6 years ago.
no writeoffs. It was neither. It was a sched C. just me.
Expert:  MequonCPA replied 6 years ago.

Dear green ... -

Assuming your Schedule C never depreciated or expensed any of the licensing agreement, your payment of the fee should be a business bad debt. The interest expense would also be deductible. Both of these items should appear either on a Schedule C or as ordinary losses on Form 4797.

You should contact a tax professional where you can provide full details to be sure the transactions are handled correctly.

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