Personally guaranteed debt

[DavidS3]

I was a principal in an LLC that went bk. I personally guaranteed much of the debt. If I now pay some of that debt, is it deductible and if so, can turbo tax handle such a deduction?

[Mike9241]

yes. it's either a non-business bad debt  - short-term capital loss entered through 1099-B worksheet or a business bad debt - ordinary deduction taken on schedule 1. 

 a guarantor is allowed a business bad debt deduction for any payment made in that capacity if the reason for guaranteeing the debt was business. It's treated as a loan to the debtor - the LLC - and the taxpayer is allowed a bad debt deduction once the loan (including any right of subrogation against the debtor) becomes partially or totally worthless (Regs. Sec. 1.166-9(e)(2)).  To claim an ordinary loss deduction, a taxpayer making payment on a loan guarantee that becomes unrecoverable must receive reasonable consideration for entering into the guarantee agreement. Consideration can be either direct (cash or property) or indirect. Indirect consideration is determined in accordance with normal business practice - example: for improved business relationships. Loans to businesses owned by the taxpayer can also generate business bad debts if the loans were made to preserve the taxpayer's employment status and income earning potential. Debts that do not qualify as business bad debts are nonbusiness bad debts.

Business Reason Must Be Dominant Motivation for the Loan

In distinguishing business and nonbusiness bad debts, the question is: Does the loss bear a proximate relation to the taxpayer's trade or business? If so, the regulations state that the debt qualifies as a business bad debt (Regs. Sec. 1.166-5(b)). However, the Supreme Court has taken it a step further and held that, in determining whether the relation is proximate, the dominant motivation for making the loan must be business-oriented (Generes, 405 U.S. 93 (1972)). Significant motivation between the debt and the taxpayer's business does not satisfy this requirement.

may be another way to put this: was this intended to be a primary source of your income (ie your trade or business) or was it just an investment that went sour.  a factor the IRS, if audited, would look at would include how much time you devoted to this.        

[DavidS3]

Thank you very much for your prompt and thorough answer. Just to clarify, I was the primary owner of an LLC, and personally guaranteed much of the debt as required by all of the lenders as a condition of the loans (the business was not strong enough to warrant a corporate only guarantee). The LLC ended up in liquidation, and I am doing my best to pay off some of the debt I personally guaranteed. I also had to file a personal bk a few years ago, but am still determined to pay some of the guaranteed debt. 

Based on your answer, it sounds like I would be able to deduct these payments as a business expense. Would I show the payments as bad debt on my schedule C? You referred to a Schedule 1 if it was a business expense, but please clarify if you meant Schedule C given that I am a sole proprietor.

Thank you again. I very much appreciate your help and guidance.