Claiming a Bad-Debt Deduction for a Shareholder Loan to a Corporation

If a shareholder's loan to a corporation becomes worthless, the debt must be considered bona fide to qualify for a bad-debt deduction [Reg. 1.166-1(c)]. To be considered a bona fide debt, the loan must meet demanding standards, especially when the shareholder is considered a related party.

Factors that the courts consider in determining whether a bona fide debt exists as a result of a transfer between related parties include:

1. The presence or absence of documentary evidence of the transaction (such as an executed note);
2. Whether there is a fixed schedule for repayment (including a maturity date);
3. Whether interest is being charged on the outstanding debt;
4. Whether collateral is obtained or requested;
5. Whether demand for repayment is made;
6. Whether any repayments have been made;
7. Whether the transaction is reflected as debt in the records of the parties; and
8. The financial condition of the debtor at the time of the loan (so that the lender can show the expectation of repayment and intent to create a valid debtor-creditor relationship).

A recent Tax Court decision (Ramig, CA-9) dated October 29, 2012 held that a corporate shareholder was not entitled to bad-debt deductions for amounts he advanced to, and paid on behalf of, the corporation because they represented equity investments, rather than loans. The corporation could not obtain loans from outside lenders, and it was not likely it could have repaid the advances from its own earnings. Although a Key Employee Agreement authorized the employee to pay expenses on behalf of the corporation, credit card charges incurred by the employee were deemed to be equity investments because the parties did not provide for interest or a repayment date, and there was no evidence the corporation had repaid similar charges in the past.

To preserve a bad-debt deduction, and support the fact that a true debt exists, shareholder loans to a corporation should always be represented by a formal note. The note should bear a fair rate of interest and should be authorized in the corporate minutes.

If you would like to discuss the proper method of documenting a shareholder loan, or would like to discuss the tax implications associated with a worthless shareholder loan, do not hesitate to contact Schneider Downs & Co., Inc. at 412-261-3644 to speak with a professional in the tax advisory services group.

© 2012 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.

This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter

our thoughts on

array(1) { [0]=> string(1) "9" }
What Happens if Your Tax Return is Lost in the Mail?
International Tax Update: OECD Releases Latest Edition of Model Tax Convention
Additional Opportunity Zone Regulations Issued
Wayfair Sales and Use Tax Legislation Developments
West Virginia Enacts Special Apportionment Rules for Motor Carriers
Sales Tax - New Legislation Wayfair Trends in 2019

Register to receive our weekly newsletter with our most recent columns and insights.

Have a question? Ask us!

We’d love to hear from you. Drop us a note, and we’ll respond to you as quickly as possible.

Ask us

contact us

Map of Pittsburgh Office

One PPG Place, Suite 1700
Pittsburgh, PA 15222
p:412.261.3644     f:412.261.4876

Map of Columbus Office

65 East State Street, Suite 2000
Columbus, OH 43215
p:614.621.4060     f:614.621.4062