Bad Debt

1
Bad Debt

• Accrual basis
• Deduction allowed when amount becomes worthless
• Reserve method not allowed
• Cash basis
• No deduction for sale on account since income not
  reported
• Deduction allowed if taxpayer lends money or
  purchases a debt instrument

2
Business vs. Nonbusiness Debt

• Business bad debt
• Ordinary loss when debt becomes partially or
  wholly worthless
• Nonbusiness bad debt
• Deductible as a short-term capital loss when
  wholly worthless

3
Loans Between Related Parties

• Bona fide loan or a gift?
• Factors to consider
• Properly executed note?
• Reasonable rate of interest?
• Collateral provided?
• Collection efforts?
• Intent of the parties?

4
Worthless Securities

• Security must be completely worthless
• Losses are capital losses
• Deemed to occur on the last day of taxable year

5
Exception for Small Business Stock ( 1244)

• General rule - Capital loss treatment for sale of
  stock
• 1244 exception
• Ordinary loss for individual shareholders
• Up to 50,000 per year (100,000 for MFJ)
• Individual must acquire from corporation
• Capitalization ceiling of 1 million when stock
  is issued

6
Casualty and Theft Losses Business vs. Personal
Use

• Business property and investment property
• Losses are generally deductible for casualty or
  theft
• Personal use property
• Losses are deductible if attributable to casualty
  or theft (subject to limitations)

7
Casualty Loss Definition

• The event that causes the casualty must be
• Identifiable
• Damaging to property
• Sudden, unexpected, and unusual in nature

8
Events That Are Not Casualties

• Insect damage
• Damage resulting from progressive deterioration
• An event that causes a decline in value rather
  than an actual loss

9
Theft Losses

• Theft includes, but is not limited to
• Larceny
• Embezzlement
• Robbery
• Theft does not include misplaced items

10
When to Deduct Casualty Theft Losses

• Casualty loss is deducted in the year incurred
• No casualty loss is allowed if it will be covered
  by insurance
• Taxpayer may elect to use disaster loss in prior
  year return
• Theft losses are deducted in the year of
  discovery of the theft

11
Amount of Casualty Theft Deductions
12
Casualty and Theft Losses Business Property

• Example 1Complete Destruction
• Corporations warehouse was destroyed by fire AB
  was 100,000 FMV was 90,000
• Loss 100,000 adjusted basis
• Example 2Partial Destruction
• Corporations warehouse was damaged by fire AB
  was 100,000 FMV was 170,000 before, 80,000
  after fire
• Loss 90,000 decline in FMV

13
Casualty and Theft Losses Personal Use Property

• Example 1Complete Destruction
• Individuals residence was destroyed by flood
  basis was 100,000 FMV was 90,000 Loss
  90,000 decline in FMV
• Example 2Partial Destruction
• Individuals residence was damaged by flood
  basis was 100,000 FMV was 170,000 before,
  80,000 after flood
• Loss 90,000 decline in FMV

14
Casualty Theft Losses Insurance Recoveries

• Reduce the loss by insurance proceeds or other
  type of recovery
• An insurance recovery may result in a casualty
  gain if the proceeds exceed the adjusted basis of
  the property

15
Casualty Theft Losses Personal Use Property
Floors

• Losses on personal use property are reduced by
• 500 (100 after 2009) per casualty
• 10 of adjusted gross income (applies to
  aggregate losses of the individual)

16
NOL Carryovers

• Length of carryback and carryforward periods
• 2-year carryback
• 20-year carryforward
• May elect to forgo carryback
• Strategy dont carry NOL back to low tax bracket
  years if tax bracket is expected to increase in
  future

17
Effect of NOL Deductions

• The NOL is offset against taxable income
• CarrybackNOL generates a refund if tax was paid
  in carryback years
• CarryforwardNOL reduces taxable income in
  carryforward years
• Only C corporations and individuals are allowed
  to deduct NOLs