The sole shareholder of ABC Corp (a WY C-Corp), was John Doe Family Trust. John Doe, an officer of the corporation, made a personal loan (promissory note) to ABC Corp and has been paying taxes on the interest received from the loan. (The corporation had no employees.)

The business has now failed/dissolved, and John Doe wants to file a short-term capital loss on his personal taxes for the unpaid promissory note, as a non-business bad debt.

Since John Doe is the trustee for the John Doe Family Trust, is it considered to be a shareholder loan (for tax purposes), or is it considered to be a loan from an officer? Is there any difference in the eyes of the IRS?

once you give money to your business to purchase inventory and the company defaults on the loan, you may qualify to write off the loan as a business bad debt versus an investment loss. A biz bad debt can be offset against other ordinary income such as W-2 income, interest and dividend income. This type of debt can also result in creating a nol on your 1040 when you don’t have enough income to offset the biz loss.

A non-business bad debt is treated as a capital loss. A capital loss will only offset capital gains. If you realize net capital loss, you can then use the loss to offset up to $3k in ordinary income. When you lend money to your corporation, the interest that you will be paid back with will be deductible to the business, but taxable to you.
When you make a loan money to your corp, you must meet conditions to qualify your debt for a loan instead of equity: a.Your debt should be documented as a written obligation that needs to be paid back by a specific date or a certain amount must be paid on demand. B.The debt cannot be converted into stocks for the corporation or any other equity interest.
c.The corp must determine interest rates and payment deadlines based upon corporation profits, decision making, and other factors. d.The lender must be an eligible shareholder of the corp, individual, estate, trust or tax-exempt entity. If a bank or individual will not make a loan directly your corp, you can use a “back-to-back” loan. Back-to-back loans are an option for lenders of corps if the lender wants personal guarantees in loaning money. In a back-to-back loan, the lender will make a loan to the shareholders who will then make a loan to the corp. When a back-to-back loan is used, tax results are far better than if a corporate loan is made.

Thanks so much for your response!

John Doe has met your items A thru C. Could you please clarify item D?

Are you saying that a qualified loan must be from an individual, estate, trust, tax-exempt entity, or an eligible shareholder?

Assuming my understanding is correct, when completing his personal tax Form 8949 statement, should John Doe say the relationship is shareholder or individual (assuming an officer is considered an individual)? I want to avoid additional questions from the IRS, if possible. (John Doe isn't in the business of loaning money, so I don't believe it can be called a business loan.)

The lender must be an eligible shareholder of the corp, AND john doe is an officer of the corp, If the corporations’ business is lending money or the debt is from the normal business activities then the loan is not considered a shareholder loan, provided standard arrangements are made for repayment and are maintained.When the shareholder loan is repaid that was previously included in income for tax purposes, it may be deducted from income of the year of payment.If the shareholder is also an employee and a loan is advanced to purchase a principal residence, new shares in the corporation, or a vehicle to be used for business purposes then the loan is not considered income.

I'm sorry. I must be dense. This just isn't clear to me. Let me try to clarify a few items:

• ABC Corp has no employees. John Doe was not an employee.
• The only shareholder is John Doe Family Trust, of which John Doe is the trustee
• The loan to ABC Corp was from John Doe
• John Doe was an officer of ABC Corp
• John Doe has been paying personal income tax on interest he received from ABC Corp for the loan
• John Doe is not in the business of loaning money
• ABC Corp used the funds for any expenses they had during the term of the loan
• ABC Corp dissolved prior to paying back the loan

I'm not sure if you are trying to say that this was not a shareholder loan? Or, are you saying that, with the information I've provided, it would not be considered a qualified loan and therefore would not be eligible for John Doe to claim as a non-business bad debt (short-term capital loss)?

Every corporation must have an Officer. A corp’s officer is an EMPLOYEE; The SSA claims that all corporate officers must take a salary for work performed.As said, J . Doe is an officer of C-corp as you said, so, he is likely receive a compensation for services provided for the corporation that compensation is normally classified as wages, reported on his W-2 form - and therefore , J.Doe would be considered an employee of the C-corp.

To the extent they have basis in the loan, the loss is a non-business bad debt on Sch D/form 8949. the loan payable will become zero and what is left from the assets/liabilities/equity will either become a forgiveness of loan.STCL for nonbusiness bad debt-whatever his loan basis is left after considering losses taken against his loan amount. If a shareholder's loan to a corp becomes worthless, the debt are not considered bona fide to qualify for a bad-debt deduction UNLESS the loan meets the conditions above, then a loan from shareholder is considered non-business bad debt and limited.
Publication 535 (2014), Business Expenses

Sorry for the delayed response. This is much more clear. Thank you!