Langert v. IRS, T.C. Memo 2014-210 (Oct. 8, 2014).
In general, the American income tax system taxes net income (only "new money") rather than gross income. Section 166 of the Internal Revenue Code helps further this objective by allowing a taxpayer to deduct a loss of money from his income if that loss occurs in connection with his "trade or business." IRC §§ 166(a) and (b)(2). Non-business bad debt losses are still deductible, but only as short term capital losses. § 166(d)(1). So legally, there is an important business boundary that must be established by the taxpayer to take full advantage of so called "bad debt" deductions.
Wednesday's Tax Court case of Langert v. IRS, T.C. Memo 2014-210 (Oct. 8, 2014) demonstrates the IRS's and the Tax Court's interpretation of this law. That is, a taxpayer seeking to deduct "bad debt" must prove that he makes enough loans on a sufficiently regular basis to elevate that activity to the status of a separate business. Id. at p. 10. In Langert, the taxpayer was a real estate investor who had also made money by lending and re-lending money over his 30 year career. Id. at p. 2. One such loan was not repaid in 2006, and the debtor filed for bankruptcy. Mr. Langert did not exercise any of his rights under the loan document, as a bankruptcy creditor, or in connection with the debtor's property. He then attempted to write off the loan as a complete loss under Section 166. His justification for doing so was that the loan was made "for the sole purpose of obtaining interest income." The IRS and Tax Court disallowed the deduction based on the taxpayer's failure to carry his burden and prove he met the "trade or business" requirements of this law.
So while many small business people may see their various and diverse business activities as related or as part of a continuum (buy low, sell high—any kind of widget), the IRS and Tax Court require more definite boundaries when it comes to deductions for bad debt. This may actually be a good case to appeal based on the language of the statute, but a prudent attorney or accountant would further research along the lines of Bell v. Commissioner, 200 F.3d 545 (8th Cir. 2000).
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