Bad Debt

In: Business and Management

Submitted By zimm4487
Words 830
Pages 4
Executive Summary: Jamie Douglas loaned her boyfriend Tom $30,000 in 2006. Tom refused to sign a promissory note with a 3% stated rate of interest and no due date. At the time the market rate was 5.5%. In 2007 Tom made a $200 payment to Jamie. Later in 2007 Jamie granted Tom a second $10,000 loan under the same conditions as the first. On December 1, 2008 Tom agreed to sign two promissory notes for the loans. In 2010 the IRS disallowed Jamie’s nonbusiness bad debt deduction disputing that the entire sum of $40,000 was a gift from Jamie to Tom and a bona fide loan never existed.

• The first loan of $30,000 occurred in 2006 while Tom was an unemployed salesman.
• The second loan of $10,000 occurred in 2007 after Tom failed to maintain steady employment.
• The debtor made one interest payment of $200 early in 2007 as a show of good faith.
• Both promissory notes were signed on December 1st 2008.
• The stated rate of interest was 3% which was below the market rate of 5.5% at the time.
• Jamie filed for the nonbusiness bad debt deduction in 2010.
• The loan had no due date.

Jamie Douglas is seeking a nonbusiness bad debt deduction from her taxable income under IRC sec. 166.1. In order to claim this deduction she must have proof that the transaction was indeed debt and not a gift. To do this Jamie must show that she and Tom had a true debtor creditor relationship and that the debt has become worthless in the year she is claiming the loss. In court the IRS contended that a bona fide loan never existed because the nature of the transaction is more appropriately classified as a gift and that repayment was contingent upon Tom getting a job. Therefore the contingency of the repayment disestablishes the debtor creditor relationship because a failure to meet the conditions will prevent the borrower from having the legal obligation to pay. The IRS…...

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