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If you simply decide to forgive the debt to your employer because of generosity - the amount of debt forgiven would be treated as wages and might be deducted as such - correspondingly - as an employer - you would be required to pay employment taxes and withhold employee's portion as well.
If someone owes you money that you cannot collect (including debt owned by your employee), 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. 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 the employee with the understanding that it may not be repaid, it is considered a compensation for services 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. A business deducts its bad debts from gross income when figuring its taxable income.
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.
12/2/12 9:54 PM
Because the loan was given to your employee would be generally considered as operating your trade or business - the debt would likely be a business bad debt - and may be deducted from gross business income when taxable income is determined.
12/2/12 10:12 PM
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