Shareholders or employees of a corporation often lend the business funds – expecting to be repaid.
If the loan does not get repaid, a bad debt deduction can be claimed. However, the tax treatment is different for “business” bad debts and “nonbusiness” bad debts.
A business bad debt results in an ordinary loss. A nonbusiness bad debt is treated as a short-term capital loss. For nonbusiness bad debts, a deduction is allowed only if the debt is wholly worthless. For a business bad debt, however, a loss is allowed for partial worthlessness.
If you lend money to a corporation that provides your primary means of employment, you may be able to show that the main purpose of the loan is to protect your trade or business as an employee. In that situation, business bad debt treatment should be available.
But if your primary motivation for the loan is an investment in the corporation, nonbusiness bad debt treatment is the result.
If you are both a shareholder in the corporation and an employee, the primary motive for making the loan may be difficult to prove.
See also: Lending Money to Family Members www.dh-cpa.com/364
Davis & Hodgdon Associates has been assisting businesses and individuals in the Burlington Vermont Metro area for more than 20 years. If you have any questions or concerns please feel free to call 802.878.1963 or email [email protected].