In the case of Owens v. Commissioner, TC Memo 2017-157, the issue to be decided involved a $9.5 million bad deduction claimed as a business bad debt an individual who took the position he was in the trade or business of lending money.  The IRS argued that he wasn’t in the business of lending money, that the debts in question were not actually debts and, even if they were, the loan did not become worthless in the year he claimed the loss.

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The taxpayer in the case of Scheurer v. Commissioner, TC Memo 2017-36 claimed that he either had a large business bad debt loss or a partnership loss related to funds that he stated he had advanced to a business being operating by a friend of his.  Unfortunately for Mr. Scheurer, the Tax Court did not accept either claim.

Mr. Scheurer had a friend, Kevin Zinn, who was planning to start a robo-call operation, marketing his company’s services to individuals with high credit card debt.  For a fee, the organization (Continental Financial Services, referred to as CFS) would contact the individual’s bank and attempt to negotiate a lower interest rate.  If a prospect agreed to hire CFS, the prospect would be charged an upfront fee that would be charged to the prospect’s credit card,

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Fred Cooper lent money to various individuals, including specifically Wolper Construction, Inc. a real estate development business.  In the case of Cooper v. Commissioner, TC Memo 2015-191 the Tax Court had to decide if Mr. Cooper could take a deduction for a bad debt in either 2008 or 2009.

IRC §166 governs the deduction of bad debts for taxpayers.  Differing rules apply depending on whether the debt in question is a business bad debt or is not one.  Generally business bad debts represent ordinary losses and a deduction can be claimed on a debt that becomes partially worthless.  A nonbusiness bad debt is deductible as a short term capital loss and for entities other than corporations per Reg. §1.166-5(a)(2), only deductible in the year in which the debt becomes wholly worthless.

Taxpayers operating a trade or business are authorized to deduct partially worthless bad debts under Internal Revenue Code §166(a)(2). But to do so the taxpayers must be able to show that they are writing off a debt that already has gone bad, rather than simply reserving against a potentially bad debt in the future.