I am an individual taxpayer.
In the case of taxpayers other than corporations, Section 166 distinguishes business bad debts from nonbusiness bad debts, providing that a business bad debt can be deducted against a taxpayer’s ordinary income, whereas a nonbusiness bad debt must be treated as a short-term capital loss. The Code defines a business debt as a “debt created or acquired (as the case may be) in connection with a trade or business of the taxpayer” or “a debt the loss from the worthlessness of which is incurred in the taxpayer’s trade or business.” Taxpayers have the burden of proving that a bad debt loss is “proximately related” to the conduct of a trade or business, or that the debt was created in the course of a trade or business.
What exactly is proximally related? I understand if I were in the business of making loans, and had a Sched C business for loans, it is pretty clear, right? But what if I founded a company making sweatshirts, making sweatshirts is my trade, and I make a loan (with promissory, board notes, and all the other boxes checked) to that C Corp, and that is defaulted on or worthless before the business goes bankrupt? Is that proximally related and becomes an ordinary deduction? If it were only loans as the business or trade, then the IRS would likely have specified that in their publications, but it was left deliberately vague as "in connection with a business or trade of the taxpayer". Thoughts on how to classify?
