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CGCPA
CGCPA, CPA
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Taxpayer was sole shareholder in a bankrupct S-Corp. Taxpayer

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Taxpayer was sole shareholder in a bankrupct S-Corp. Taxpayer personally guaranteed loans made to the corporation by third parties. Because of the personal guarantees taxpayer has had to pay these loans plus interest. Are these payments deductible by the taxpayer? If so, are they deductible as business bad debts, non-business bad debts or miscellaneous itemized deductions?
Submitted: 3 years ago.
Category: Tax
Expert:  CGCPA replied 3 years ago.

Welcome to Just Answer. I am here to help you resolve your tax and finance concerns. Please feel free to ask anytime you need extra help.

These are deductible as business bad debts since they are payments made on behalf of a business from whom there is no hope of recovery. Here is a short piece from the IRS concerning this. You can read more, should you so chose, at the IRS web site www.irs.gov

Topic 453 - Bad Debt
Deduction

If someone owes you money that you cannot collect, you may have a bad debt.
For a discussion of what constitutes a valid debt, refer to Publication 550, Investment Income
and Expenses
, and Publication
535
, Business Expense.
To deduct a bad debt, you must have previously included the amount in
your income or loaned out your cash. If you are a cash basis taxpayer, you may
not take a bad debt deduction for money you expected to receive but did not (for
example, for money owed to you for services performed, or rent) because that
amount was never included in your income. For a bad debt, you must show that
there was an intention at the time of the transaction to make a loan and not a
gift. If you lend money to a relative or friend with the understanding that it
may not be repaid, it is considered a gift and not a loan.

There are two kinds of bad debts - business and nonbusiness.

Generally, a business bad debt is one that comes from operating your trade or
business.

The following are examples of business bad debts (if previously included in
income):


  • Loans to clients and suppliers
  • Credit sales to customers, or
  • Business loan guarantees

A business deducts its bad debts from gross income when figuring its taxable
income. Business bad debts may be deducted in part or in full. You can claim a
business bad debt using either the specific charge-off method or the
nonaccrual-experience method.

All other bad debts are nonbusiness. Nonbusiness bad debts must be totally
worthless to be deductible. You cannot deduct a partially worthless nonbusiness
bad debt.

A debt becomes worthless when the surrounding facts and circumstances
indicate there is no reasonable expectation of payment. To show that a debt is
worthless, you must establish that you have taken reasonable steps to collect
the debt. It is not necessary to go to court if you can show that a judgment
from the court would be uncollectible. You may take the deduction only in the
year the debt becomes worthless. You do not have to wait until a debt is due to
determine whether it is worthless.

A nonbusiness bad debt is reported as a short-term capital loss in Part 1 on
Form 1040, Schedule D (PDF). It is
subject to the capital loss limitations. A nonbusiness bad debt deduction
requires a separate detailed statement attached to your return.

For more information on nonbusiness bad debts, refer to Publication 550, Investment Income
and Expenses
. For more information on business bad debts, refer to Publication 535, Business
Expenses
.

Customer: replied 3 years ago.
Which schedule on the 1040 is the business bad debt deducted?
Expert:  CGCPA replied 3 years ago.
It is deducted on Schedule A (itemized deductions) on line 28. It will need to be identified (business bad debt). You should also consider an attachment explaining the nature and amount of the deduction.Then, if your return is pulled for a desk review (the preliminary step before an audit) the reviewer can see what this is about and may over rule the audit decision.
CGCPA, CPA
Category: Tax
Satisfied Customers: 3742
Experience: over 40 years experience in tax matters
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