By paying the debt of your C-Corp, you have made a loan to the C-Corp, or an equity contribution (investment) depending on your 'agreement.' If the C-Corp then closed and you were the one left holding the bag, you'll have your stock basis / bad debt losses to deduct.
As an individual, you will not record the business expenses of the C-Corp though. These get recognized on the 1120 return, and never your 1040 return.
Worthless securities can be long/short term capital losses and bad debt is a short term capital loss. The corporation (if solvent) would recognize taxable forgiveness of debt income in the absence of a legitimate capital contribution as it restores net equity to $0.00, but either way, your investment in a loan/stock is just that, an investment, while the operating expenses of the corp are stuck in the corp along with any potential NOL carryforward.
The one way you can use the NOL, since you went with a C-Corp and not an S-Corp to begin with, is to generate revenue and run it through the C-Corp. This will allow the NOL carryforward to offset income...
Thank you for your question.
My concern with your answer is that the Corporation was bankrupt and no longer in operation when we paid the guarantees. Essentially, banks were loaning to us to operate the company, not the corporation. The corporation may have been the principal obligor, but no loans would have occured without our endorsement. Why is this not trade or business, rather than paid in capital; and can you pay in capital if the corporation no longer existed? In another answer on your website, the answer was:
Dear XXXXXXXXXXXXXXXXXX -
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.
Why do we not fit in this category? We're talking about $400,000 and at 3,000 per year even divided by 3 we may as welll not.
Thank you in advance for your time.
I agree with the above about business bad debts. You can wrap them into an NOL too...
Actually, here is the actual tax code. It's a lot more clear than the publication and is the highest authority outside of judicial review:
How Current is This?
(a) General rule
(1) Wholly worthless debts There shall be allowed as a deduction any debt which becomes worthless within the taxable year.
(2) Partially worthless debts When satisfied that a debt is recoverable only in part, the Secretary may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction.
(b) Amount of deduction For purposes of subsection (a), the basis for determining the amount of the deduction for any bad debt shall be the adjusted basis provided in section 1011 for determining the loss from the sale or other disposition of property.
[(c) Repealed. Pub. L. 99-514, title VIII, § 805(a), Oct. 22, 1986, 100 Stat. 2361]
(d) Nonbusiness debts
(1) General rule In the case of a taxpayer other than a corporation-
(A) subsection (a) shall not apply to any nonbusiness debt; and
(B) where any nonbusiness debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 1 year.
(2) Nonbusiness debt defined For purposes of paragraph (1), the term "nonbusiness debt" means a debt other than-
(A) a debt created or acquired (as the case may be) in connection with a trade or business of the taxpayer; or
(B) a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business.
As long as the C-Corporation hadn't ceased existence (ie... you hadn't filed a final tax return), you're fine. You can deduct this as a business bad debt, again, depending on the nature of your relationship... you say you are an employee-shareholder who was personally liable for the debt of your C-Corp. I believe you'll qualify just fine then.
Again, thank you for your question.
Unfortunately, Section 166 does not apply to securities:
166(e) Worthless securities This section shall not apply to a debt which is evidenced by a security as defined in section 165 (g)(2)(C).
(g) Worthless securities
(1) General rule If any security which is a capital asset becomes worthless during the taxable year, the loss resulting therefrom shall, for purposes of this subtitle, be treated as a loss from the sale or exchange, on the last day of the taxable year, of a capital asset.
(2) Security defined For purposes of this subsection, the term "security" means-
(A) a share of stock in a corporation;
(B) a right to subscribe for, or to receive, a share of stock in a corporation; or
(C) a bond, debenture, note, or certificate, or other evidence of indebtedness, issued by a corporation or by a government or political subdivision thereof, with interest coupons or in registered form
(3) Securities in affiliated corporation For purposes of paragraph (1), any security in a corporation affiliated with a taxpayer which is a domestic corporation shall not be treated as a capital asset. For purposes of the preceding sentence, a corporation shall be treated as affiliated with the taxpayer only if-
(A) the taxpayer owns directly stock in such corporation meeting the requirements of section 1504 (a)(2), and
(B) more than 90 percent of the aggregate of its gross receipts for all taxable years has been from sources other than royalties, rents (except rents derived from rental of properties to employees of the corporation in the ordinary course of its operating business), dividends, interest (except interest received on deferred purchase price of operating assets sold), annuities, and gains from sales or exchanges of stocks and securities.
Here is 1504(a)(2):
(2) 80-percent voting and value test The ownership of stock of any corporation meets the requirements of this paragraph if it-
(A) possesses at least 80 percent of the total voting power of the stock of such corporation, and
(B) has a value equal to at least 80 percent of the total value of the stock of such corporation.
Do you own 80% directly (ie... not even indirectly)?.... It's a capital loss.
We've had no activity and haven't filed an 1120 in 3 years. We couldn't file a final 1120 until the IRS was paid off (per their orders).
Based on this and the other facts, I understand your answer to be that we could file the loss on our individual 4797s rather than on the D. Do I understand correctly?
I suggest filing zero returns for the missing years.
To sum my posts above, if you paid debt on behalf of a C-Corp, and you're not a direct 80% owner, then you're going to have to make a choice: It's an equity contribution or a debt that has to be repaid (you would expect 'repayment' from your brothers for your share, or for them to put in an equal share, and the IRS could impute interest on all of you if you treat this like a loan and not a capital contribution). Because the definition of a security can be read as "note, ... or other evidence of indebtedness ... issued by a corporation ... with interest coupons" I think paying the debt of the C-Corp when you didn't have to falls under the investment category ('interest coupons' means interest is to be, or should be, paid, which would be required if you are making a loan and not an equity contribution to the C-Corp).
If this were a sole proprietorship, or you were active in an S-Corp or Partnership, that's one thing, but as an employee it is not normal to loan your boss money to keep the company going, but rather, that is something you do as an investor, which is why the 80% test is the determining factor for an affiliated C-Corp. It's therefore aggressive to go about saying you made this loss in Your trade or business, making it deductible under Section 165... 165(c)(2) applies to capital (investments) assets while (c)(3) personal assets that are stolen or lost due casualty:
(c) Limitation on losses of individuals In the case of an individual, the deduction under subsection (a) shall be limited to-
(1) losses incurred in a trade or business;
(2) losses incurred in any transaction entered into for profit, though not connected with a trade or business; and
(3) except as provided in subsection (h), losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft.
If you're going to do this, get a CPA.
still editing... you've got a tough question for citing code...
Here is another CPA's opinion (presumably anyways, 'jdugancpa'), posted here (he seems to have experience with this particular situation.... I suggest you read the thread):
Jdugancpa (talk|edits) said:
You've got a tough one. I actually just did quite a bit of work, because I feel for you. Normally, I would never take that much time for $15, which is my share of a $30 question on here, so please recognize that I'm being nice and you're getting a good deal here (it's not all about the money to me on this site...). In the same fashion, given I'm trying to help you here, trust me when I say "Go see a CPA!" There is no one-size-fits all answer. For this kind of money, even though I realize things didn't work out, you should be sitting down face to face with a professional and not paying $30 over justanswers, so I'll assume that was probably already your intention...
I sincerely XXXXX XXXXX the best of luck.
Here is a bonus answer:
§ 1244. Losses on small business stock
(a) General rule In the case of an individual, a loss on section 1244 stock issued to such individual or to a partnership which would (but for this section) be treated as a loss from the sale or exchange of a capital asset shall, to the extent provided in this section, be treated as an ordinary loss.
(b) Maximum amount for any taxable year For any taxable year the aggregate amount treated by the taxpayer by reason of this section as an ordinary loss shall not exceed-
(1) $50,000, or
(2) $100,000, in the case of a husband and wife filing a joint return for such year under section 6013.
(c) Section 1244 stock defined
(1) In general For purposes of this section, the term "section 1244 stock" means stock in a domestic corporation if-
(A) at the time such stock is issued, such corporation was a small business corporation,
(B) such stock was issued by such corporation for money or other property (other than stock and securities), and
(C) such corporation, during the period of its 5 most recent taxable years ending before the date the loss on such stock was sustained, derived more than 50 percent of its aggregate gross receipts from sources other than royalties, rents, dividends, interests, annuities, and sales or exchanges of stocks or securities.