Bad Debt From S-Corporation- Time Limit To Deduct On Personal Return Question

[PGB12]

Hello All!

I apologize if the answer is here somewhere, but I could not find it. On the general internet, I found conflicting answers. The IRS documents, while helpful in other ways, didn't help me figure out the time limit to deduct a bad debt from a business that I owned.

Details That May Help-

In 2009, I opened a business as a Subchapter S corporation with LLC status. I was the only shareholder.

The effects of the covid-19 pandemic eventually caused the demise of the business.

When I opened the business, I took $1,000.00 of my wife's & my personal money to purchase things for the business. There is formal paperwork from 2009 showing this loan from our own money.

On 12-31-2022, I formally closed the business. Paperwork was filed as needed with the IRS and the state (Michigan). The 2022 income tax return (1120-S) for the business was the Final Return, as was the K-1.

Every year I have recorded the 1,000.00 mentioned above on 1120-S, Schedule L, Line 22 as Capital Stock. The final return shows the 1,000.00 in the "ending" column.  The business never paid us back.

The Question-

Can I deduct this bad debt on our 2023 personal income tax return on Form 8949 as a bad debt?

Or

Has the time limit passed since it is a Personal bad debt?

Thank You for clarifying my confusion. I appreciate it very much.

Paul

[tagteam]

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

[PGB12]

Thanks TagTeam.

I read the article you linked again, plus Publication 550 & still can't find if there is a time limit to deducting this debt.

[Mike9241]

Definitely not deductible.  First, losses between married people (related parties is not allowed)  Second, that $1,000 gives the shareholder tax basis. Losses of a S-corp reduce the shareholder's tax basis. if any assets were left they were either written off or withdrawn. These also reduce your tax basis.  Since it's highly probable that your tax basis was zero there's nothing left to write off. Double dipping is not allowed.  Also, with an S-Corp for the last few years form 7203 was required and will be required for 2023. if done properly it tracks tax basis. Once your basis goes negative, further losses are not deductible. Schedule L may show $1000 as common stock but isn't there a negative $1000 or more on line 24, Retained Earnings, of Schedule L. Isn't M-2 column a line 8 a negative $1,000 or more? 

[Rick19744 · Accepted solution]

I agree this is not deductible.

• First there is conflicting "accounting" for this $1,000.
  • You indicate that there is documentation that this is a "loan"
  • However, you have not recorded this as a loan on your books and records.  You indicate that this was recorded as a capital contribution (capital stock)
  • If you were ever audited, I believe the IRS would look at all the supporting facts and come to the conclusion that is was in fact a capital contribution.
• Since this is a capital contribution, as noted by @Mike9241 you should have been tracking your tax basis in the S corporation.  This capital contribution would have increased your tax basis and you would have used this basis to take ordinary losses being passed out by the S corporation.
• There are not sufficient details to understand much more than that.  There are no details as to what your tax basis was when you closed the S corporation.  This is key to understanding if you in fact had any tax basis left to claim a capital loss or whether it was at zero and no further deductions were available.
• Additionally, were there any assets distributed out to you when the S corporation was liquidated?
  • Depending on the assets distributed, there could have been gain on the liquidating distribution
  • Too many unknown facts to provide help in this area
• My final recommendation would be to spend maybe a couple of hundred bucks to visit a tax professional, provide them with the final return and facts, and they should be able to determine if there were any additional losses available upon liquidation or whether you need to amend any returns.

[Opus 17]

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@PGB12 wrote:

Thanks TagTeam.

I read the article you linked again, plus Publication 550 & still can't find if there is a time limit to deducting this debt.

---

A non-business bad debt is deductible in the year the debt becomes uncollectible.  This may vary depending on the type of debt.  For example, if you pay a deposit to a contractor to remodel your kitchen, and the contractor goes out of business, you must first take all legal steps to collect the debt before you can deduct it.  That might mean suing the contractor, or listing yourself as a creditor in their bankruptcy proceeding, which means the debt is not fully uncollectible until the legal case is settled and you either recover something or nothing.  So the actual date of the tax deduction could be some time down the road from the loss.

However, I agree that a debt to yourself to open your own business is not eligible to be treated as a non-business bad debt. 

[PGB12]

Thank You to you each for helping me understand. I appreciate the time you each took to explain with helpful information.

It seems that I misunderstood the difference between personal money used to open the business (beginning basis) and having an un-collected debt from not my wife nor myself- such as an un-collectable invoice from a customer.

To make sure I understand:

Since the 1,000.00 was used to open the business, it is not a bad debt, but rather it is part of my basis in the company. Therefore it should have been included in the ongoing basis calculations. The end result is that my ending basis was 1,000.00 less than it should have been.

As far as hiring a tax professional; that is who has been doing the returns. However, the CPA made herself unavailable when the IRS questioned things on a previous year's return that she prepared, so I handled the closing of the business myself.

I'll be certain not to include the 1,000.00 as a bad debt on our personal income tax returns.

Thanks Again All!

Paul

[Rick19744]

@PGB12 

• Based on the limited facts, you are correct in that we believe that the $1,000 should have been included in your ending tax basis of your investment in the S corporation.
• While there are not sufficient facts to provide an accurate determination for your 2022 tax return, if the $1,000 was not included in your tax basis when you filed the final S corp return, your 2022 personal tax return may need to be amended.  The issue at hand all relates to your 2022 tax return. 
• Based on your response, I would find another CPA that provides support when you need it most, and that is when the IRS questions your tax return.