Bad Business Debt: Guarantor

[rjulius]

I am the guarantor of a bank business loan for a C-Corp that I co-founded in 2000. The loan was taken out around 2003 and was used for payroll for the co-founders, who materially participated in the business (as full time employees) when the loan was incurred. The corporation closed this year (2019) leaving me and the other founder to pay off the business loan (about $10k each) which we paid this same year. According to Sec 166 of the tax code, I can deduct the amount of the loan guarantee that I paid to the bank as a Bad Business Debt. However, I do not see where to do this. The guidelines I have seen say that you pay off a Bad Business Debt on Schedule C, but I am the guarantor, an individual, not a business. Do I handle it on Schedule C as if I were a sole proprietor? The law is pretty clear that as a guarantor who materially participated in the business as an employee, that I can claim Bad Business debt and not NonBusiness Debt (which caps at $3000). But I just do not have a clear sense of what form/line to use in TurboTax for this. Thanks in advance for all advice. 

[RobertG]

Yes, you would  report it on Schedule C as if you were a sole proprietor

According to IRS Publication 535 a business bad debt is one that comes from operating your trade or business. You can deduct business bad debts on Schedule C (Form 1040) or your applicable business income tax return.

A business bad debt is a loss from the worthlessness of a debt that was either:

• Created or acquired in your trade or business, or

• Closely related to your trade or business when it became partly or totally worthless.

A debt is closely related to your trade or business if your primary motive for incurring the debt is business related. 

[rjulius]

I'm still a little unclear. I understand that I would enter the Bad Business debt on Schedule C. But does it go under Other Expenses? And since I do not actually have a business, is that the only entry on that form? And do I check the "Did you materially participate" checkbox? (Remember, the purpose is only to indicate the amount I had to pay the bank as the guarantor of a C corporation that closed, leaving me with the debt.) Thanks! 

[ThomasM125]

If you consider the bad debt to be a business bad debt, then you have to deduct it on the business return to which it relates. 

However, if you weren't in the business of loaning money, it is more likely the bad debt is a personal bad debt, in which case you would report it as a short term capital loss on your personal tax return. You can do so in TurboTax as follows:

1. Find the "Income and Expenses" menu option in your TurboTax program

2. Find "Investment Income" in the list of categories

3. Click on "Stocks, Mutual Funds, Bonds and Other"

4. Work through the program to find "Choose the type of Investment you Sold"

5. Choose the "Uncollecible Debt (Nonbusiness Bad debt)" option in the list of investments

6. Enter the information requested about your uncollected debt