$14,000 lost due to Travel Agency declaring bankruptcy due to COVID-19

[mjkuhn]

My paid for trip was cancelled due to COVID restrictions. Travel Agency then declared bankruptcy after spending everyone's money. Can I claim a loss for this on tax return?

[Opus 17]

This is probably a non-business bad debt and is reported in the same way as an investment loss.  You can deduct the loss against other investment gains, if you don't have investment gains, you can deduct up to $3000 per year and carry the rest forward until you use it up.

https://www.irs.gov/taxtopics/tc453

https://turbotax.intuit.com/tax-tips/irs-tax-return/how-to-report-non-business-bad-debt-on-a-tax-ret...

Somewhat strangely, this is reported in the "Income" sections under "Sales of stocks, bonds and other assets."  I believe you list the asset type as "Other", and then you will get some questions about the type of loss and you should be able to select bad debt as one of the options.  The purchase price is what you paid and the selling price is zero (assuming the debt is worthless).

Note you can't claim a bad debt deduction until your loss is final.  That means that if the bankruptcy proceeding is ongoing and there is a chance you will be paid something (even if only a little of what you are owed) you can't claim the bad debt deduction.  You have to wait until the proceedings are final and there is no chance of recovering any more of your loss.  (For example, if the bankruptcy is in court until 2023 and you eventually get repaid $500, you could take the deduction on your 2023 tax return in the amount of $13,500, but you can't take it now because it is not final.)

You also have to make bona fide efforts to collect.  If the travel agency has a legal bankruptcy case, you must get yourself listed as a creditor on the case.  If they didn't file for formal bankruptcy, you must sue them in court, or take other bona fide and legitimate steps to collect.  You can't just shrug your shoulders, walk away, and put it on your taxes.  

Also beware, if this is categorized as a theft by the authorities (for example, the police arrest the travel agents and charge them with stealing funds from their clients), that converts this from a non-business bad debt to a theft loss, and theft losses are not deductible after 2018 tax reform.  Hopefully that will not come up in this case. To be a bad debt and not a theft loss, there has to have been a genuine and enforceable contract where you provided funds and the other party was supposed to provide something of equal value. 

See also page 54 here https://www.irs.gov/pub/irs-pdf/p550.pdf

[macuser_22]

Also, you must make your claim in the tax year that the debt became worthless.   As pointed out above, if you do not have other capital gains that the loss can offset, then only $3,000 per year can be used to offset ordinary income so at $3K/year it will take 5 years to claim it all.    Any amount not used in a given year will carry to the next yea but DO NOT SKIP a year, even if you have no taxable income to claim for that year.   If not claimed for any year, even if the deduction will be zero for that year,  will forfeit any reaming amount from carrying forward to the next year.     

That is a mistake that many taxpayers make - they think it need only be claimed if there is enough taxable income to receive a deduction and then don't understand why the IRS disallowed the deduction.

[M-MTax]

This would be a theft loss because what happened in a legal sense is embezzlement. There was no debtor-creditor relationship that would support a bad debt claim. 

[macuser_22]

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@M-MTax wrote:

This would be a theft loss because what happened in a legal sense is embezzlement. There was no debtor-creditor relationship that would support a bad debt claim. 

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A contract for a future service that you pay for establishes that relationship.

That reply does not agree with the facts presented.    The poster said that this was a travel agency that declared bankruptcy.    An embezzlement  is a crime that cannot be discharged in bankruptcy.    If bankruptcy was filed (and accepted by the court) then it is probably another mismanaged travel agency  which  is bad, but not criminal.   But, as the first answer said,  if an investigation shows that the travel agency was a scam to defraud money than it can be theft if charges are filed.

(BTW: there are many cases like that where travel agencies  booked trips and  paid in advance that the trip provider could not provide due to the CLOVID shutdown and the agency was unable to get the money back  because the trip provider went out of business, so they were caught in the middle and went out of business and declared bankruptcy as a result.)

There are too many unknowns for a definite answer.

[M-MTax]

A contract for a future service that you pay for establishes that relationship. That reply does not agree with the facts presented.    The poster said that this was a travel agency that declared bankruptcy. 

It is a THEFT loss because a theft loss includes embezzlement. @mjkuhn suffered a loss because the travel agent embezzled the money NOT because the travel agency filed bankruptcy. The proximate cause was the crime of embezzlement and that's how the IRS would view this. If you want to give advice that would likely get posters on this board in trouble then be my guest. Not a good idea though.

[mjkuhn]

Agency was informing clients that we could reschedule another trip, in my case it was jan 2022. So money paid was not disbursed. Examiner had issues with Agency keeping money deposited for trips in the same bank account as was used to pay operating expenses and salaries. As 2020 progressed the trip deposits disappeared.

[Opus 17]

@M-MTax 

Not necessarily, your opinion is far too black-and-white for the facts as we know them.

Back when theft losses were still deductible, there was sometimes considerable advantage in deducting a loss as a theft rather than as a bad debt, because the theft could be deducted all at once even though it was subject to a 10% limitation, while a bad debt can only be deducted $3000 per year.  In such cases, the IRS ruled that in order for there to be a theft, there must be a person or persons who benefit illegally. In other words, there must be a criminal in order for there to be a crime.  

A failed business is not necessarily a criminal enterprise.  that’s why I indicated in my original answer that it might not be a bad debt deduction if local authorities charged the travel agency owners with criminal offenses. In the absence of criminal charges, I don’t see how the IRS can object to a bad debt deduction. It can’t be a crime unless there is a criminal. That’s from the IRS themselves back when taking a theft deduction was an option.

[M-MTax]

I don’t see how the IRS can object to a bad debt deduction.

More info posted by @mjkuhn and it looks like there was an offer for rescheduling the original trip. So it's looking less and less like a bad debt and also less like theft. If there was no clause providing for a refund in the contract.......if there even WAS a formal written contract......it looks kind of hopeless in terms of any kind of a tax deduction.