It may be too early to do anything on his 2016 taxes if the matter isn't settled yet.
Also, you may need to refer this to his attorney. There is a lot going on here and it is not simple at all. You say that Mr. Jones "invested" $20,000 with your boss Mr. Smith on the promise of 25% interest in 90 days. (That sounds shady to begin with.) But then Mr. Jones invaded Mr. Smith's bank account and withdrew $38,000 "without receipts". You also never say if the business was a schedule C sole proprietorship, or an LLC, S corp or C corp.
So it's not clear whether Mr. Jones invested in the business, or loaned the business money, or became a partner in the business (which are three different things). And it's not clear whether the $38,000 was embezzlement by a partner, or theft by an unrelated person who got hold of banking information. And it's not clear whether your boss's actual loss is $38,000 or $18,000.
The tax treatment of business bad debts is different from the treatment of theft. If this is theft from Mr. Smith personally, it can be deducted on his personal tax return subject to 2 deductibles, 10% of adjusted gross income and $100. But if he recovers money later in court, that money has to be added to his taxable income in the year of the recovery.
If this is theft from the business, it is a deductible expense against the business. The same rule about any recovery being taxable applies.
If this is a disputed business debt, then it can't be dealt with on the tax return until it is finalized in court and the final about of loss is determined. If there is a judgement against Mr. Jones, the debt still can't be deducted until a final determination is made that the debt is uncollectible, and only after making reasonable efforts to collect the debt.
I don't think you want to be dealing with this. And I don't think you even want to be doing Mr. Smith's personal taxes, there are too many mistakes you could get blamed for.
