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I made a loan to a friends business that eventually went out

I made a loan to...
I made a loan to a friend's business that eventually went out of business. The business did pay me back for the loan and the business was sued and I had a judgement placed against me since I received money from the business. I've paid off the judgement and wanted to know if this is tax deductible?
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6/1/2011
Jax Tax
Jax Tax, Tax Attorney
Category: Tax
Satisfied Customers: 1,408
Experience: JD, LL.M in Business and Taxation, IRS Enrolled Agent. Expert in Business and Tax Transactions
Verified

Jax Tax : Welcome to JA. I am here to help.
Jax Tax :

I am assuming that since you lost the suit and had a judgement filed against you, that you could not prove that you have made a loan. You did not have a loan contract nor were you paid periodically principle and interest. Is this correct?

Jax Tax :

You can write off the loan as bad debt if

Jax Tax :

There must be a true relationship between the creditor and the debtor if you lend money to someone. You must have bona fide documents showing the debtor's obligations towards your money. The main intention is to determine that you have lent money to be repaid, and not as a gift. The document can contain details of



  • The size of loan amount

  • Who has taken the loan?

  • When and how the loan need to be repaid


If you have already recorded the amount in your income or loaned out your cash, bad debt can be deductible in income tax.


To write off non-business bad debt in tax return, it must be totally worthless in that year. Unlike business bad debts, partially worthless non-business bad debts are non-deductible.

Jax Tax :

The loss is taken as short term capital loss on Sch D.

Customer:

yes, my friends business. $30k loan.

Jax Tax :

The loss is then offset against other capital gain first then at $3000 per year which can be carried back 3 years by amending returns or forward

Jax Tax :

If you are audited, you would have to prove the debt was a loan.

Jax Tax :

Hopefully this answers you question. If so, please accept so that I receive credit and leave a comment if you would like.

Jax Tax :

Do you have any further questions?

Customer:

I paid the judgement in full, can I use this paperwork? I do not have any loan paperwork, just a handshake agreement.

Jax Tax :

If the judgement states that it was a loan. My thought is the judgement was issued against you because the court determined it was not a loan. There could be other reasons. What was the reason why they were able to come after you?

Customer:

I had ownership in another business that we were partners and they tied both together. My amount was tiny compared with the other judgements.

Customer:

My partner had mixed some of the banking accounts, that where they tied together.

Customer:

Sounds like no hope for a write-off

Jax Tax :

Do you still operate the business or a business?

Customer:

no

Customer:

closed several years ago

Jax Tax :

When was the judgement entered and when was it paid? What year?

Jax Tax :

Was the judgement amount tied to the loan repayment amount at all?

Customer:

entered in 2008, paid in 2009

Jax Tax :

Was the judgement amount tied to the loan repayment amount at all?

Customer:

no, the loan was $20k and judgement was negotiated at $30k

Jax Tax :

So, this was a settlement not a judgement?

Customer:

yes, sorry that is correct

Jax Tax :

Perfect

Jax Tax :

In my opinion, the settlement of a dispute tied to business dealings is not punitive in nature and would qualify as a business expense. Since the business has closed this is a business expense ongoing after the closing of the business and where it is deducted depends on what business structure you operated. Was your business and LLC, S Corp, Corp, Sole Prop, or Partnership?

Customer:

S Corp

Jax Tax :

Did you get a K-1?

Customer:

no

Jax Tax :

Who paid tax on the S Corps profit?

Customer:

no profit, the business was a new entity and operated for less than 2 years

Jax Tax :

Who took the loss?

Jax Tax :

An S corp issued K-1s to the owners always.

Customer:

the business ran out of money and nothing was filed, plus the law suit etc

Jax Tax :

OK. Past the fact that they should have been filed. The expense is best taken on 1040 Sch E pg 2 as an unreimbursed partnership expense.

Customer:

ok thank you

Jax Tax
Jax Tax, Tax Attorney
Category: Tax
Satisfied Customers: 1,408
Experience: JD, LL.M in Business and Taxation, IRS Enrolled Agent. Expert in Business and Tax Transactions
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Jax Tax
Jax Tax
Jax Tax, Tax Attorney
Category: Tax
Satisfied Customers: 1,408
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Experience: JD, LL.M in Business and Taxation, IRS Enrolled Agent. Expert in Business and Tax Transactions

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