C Corp Dissolution - Losses?

[LorianneH]

If a C Corp dissolves with losses, are the shareholders able to deduct losses for loans and unreimbursed expenses on their individual tax returns?

[Abby Normal]

No for the losses inside the corporation, but the loans and unreimbursed expenses are all capital losses on the 1040.

[cred65]

You may consider a Business Bad Debt on Form 4797. Not knowing all the facts I have attached some case law of which I had sucess.


Business versus nonbusiness bad debt:
Dagres, 136 T.C. No. 12 Filed 3/28/2011

“Section 166 distinguishes between business bad debts and nonbusiness bad debts. Sec. 166(d); sec. 1.166-5(b ), Income Tax Regs. Business bad debts may be deducted against ordinary income and are deductible whether such debts become wholly or partially
worthless during the year. Nonbusiness bad debts may be deducted
only as short-term capital losses and only if the debts become
wholly worthless in the year claimed. Sec. 166(d). A bad debt
is characterized as business rather than nonbusiness if the debt
bears a proximate relationship to the taxpayer's trade or
business. Sec. 1.166-5(b ), Income Tax Regs. In determining
whether such relationship exists, the proper measure is the
taxpayer's dominant motivation; a significant motivation is not
sufficient.

The business nexus required for deducting a bad debt under
section 166(a) exists where the dominant motive in incurring the
debt was protecting or enhancing the taxpayer’s trade or
business.”

Dominant motivation is the key in determining the classification of the bad debt. If loans to the business can be documented as to keeping the business alive, this factor should serve to justify a business bad debt. “Protecting and enhancing the business” is cited in the court cases as substantial reasons.


Rezazazadeh, T.C. Memo, 1996-245 file 3/28/1996

“In determining the dominant business or nonbusiness motive of a shareholder lending money to a corporation in which the shareholder is also an employee, courts look primarily to three objective factors: The amount of the loan with the taxpayer's investment in the corporation, the amount of the taxpayer's after-tax salary, and other sources of gross income available to the taxpayer at the time of the loan. United States v. Generes, supra; Scifo v. Commissioner, 68 T.C. 714, 723 (1977); Shinefeld v. Commissioner, 65 T.C. 1092 (1976). The larger the taxpayer's investment, the smaller his salary, and the larger his other sources of gross income, the more likely the courts are to find a dominant nonbusiness motive for the loan. On the other hand the more significant the after-tax salary from this business is to the overall gross income of the taxpayer and in relationship to the amount loaned to the business, the better chances for a business bad debt.”

[DANRVAN]

 

In the case of Graves v. Com., the Ninth Circuit held that a shareholder/employee loan to bankrupt corporation was a miscellaneous itemized deduction subject to the 2% floor given the facts and circumstances of the case.

Several years ago I had a client with a similar situation.  The 2% haircut  yielded a far better deduction than the capital loss limitation.