International Law Issues

Business Bad Debt - Employee Bad Debt

2011-09-27T10:12:00.001-07:00

Bad debt income tax deductions in the U.S. are available to some taxpayers who can meet the complex IRS regulations pertaining to qualifying bad debt. Both individuals and business taxpayers may qualify for bad debt tax deductions depending on the nature of their accounting system, how the debt was acquired, and what steps have been taken to attempt collection.

Whether a debt is business or nonbusiness is a mixed question of fact and law. The taxpayer bears the burden of proving that his facts are such that the bad debt meets the definition of a business bad debt for tax purposes.

Section 166(d)(2) and Regs. Section 1.166-5(b) define a nonbusiness bad debt by a process of exclusion, that is, a debt other than:

(A) one created or acquired in connection with the taxpayer-creditor's trade or business; or

(B) the loss from the worthlessness of which was incurred during the operation of the taxpayer-creditor's trade or business.

In order to qualify as a business bad debt under the first rule of exclusion, the worthless debt must have been created or acquired in the particular taxpayer's trade or business.

As part of this analysis, it is essential to keep in mind that the employment relationship must be the taxpayer's dominant motivation for making the loan. It is not sufficient that considerations of the taxpayer's employment were merely important to the decision to make the loan. See U.S. v. Generes, 405 U.S. 93 (1972).

In Litwin v. U.S., 91-1 USTC Para.50,229 (D. Kan. 1991), aff'd, 983 F.2d 997 (10th Cir. 1993), the district court found that the loans and guarantees made by an 83-year-old shareholder outstripped his expected annual salary and exceeded his financial risk by more than three times. Therefore, the court held that the taxpayer had not willingly risked these funds for an anticipated return on investment; instead, the court found that all of his actions evidenced a desire to continue to use his managerial skills to run the business. In other words, the taxpayer made the loans and guarantees because he wanted to be actively employed in responsible positions and to enjoy the rewards of his work (i.e., salary and personal achievement). On appeal, the Tenth Circuit affirmed the district court in Litwin, concluding that the district court had before it substantial evidence of the taxpayer's business purpose in making the loans and guarantees.

In Jaffe v. Comr., T.C. Memo 1967-215, T.C. Memo 1967-215, worthless loans by two employees who owned all the stock of the corporation were deductible as business bad debts, because the loans were made in order to protect their jobs. One employee was 70 years old and would have been unemployable if he had lost his job with the debtor.

In Carter v. Comr., T.C. Memo 1979-447, the taxpayer was found to have lent money to his controlled corporation to protect his employment where the corporation had incurred substantial losses and very likely had little value as an investment.

In Fitzpatrick v. Comr., T.C. Memo 1967-1, the taxpayer prevailed because he showed that at age 65, he would have had difficulty finding other employment at another company, and thus his dominant motivation for the loan was to protect the employment arrangement he already had.

In Avery Est. v. Comr., T.C. Memo 1969-64, the taxpayer prevailed where he formed the debtor corporation as a means of exploiting his own talents. The decisive factor was that his personality prevented him from working under any other arrangement.

In Pierce v. Comr., T.C. Memo 1986-552, the taxpayer established that the loan in question was with a view toward prospective employment.

Joseph Story

2011-09-24T07:46:00.000-07:00

Joseph Story served on the U.S. Supreme Court from 1811 to 1845. One of his major works was Commentaries on the Constitution of the United States, which was first published in 1833.

Parallel Proceedings

2011-09-24T07:33:00.000-07:00

Due to the general lack of statutory or constitutional provisions in federal and state law governing parallel proceedings in U.S. and foreign courts, U.S. courts often looked to several common law approaches taken in domestic U.S. parallel proceedings and modified them for U.S. - foreign court parallel proceedings. The court mechanisms are as follows:

Forum non conveniens permits a U.S. court to dismiss an action in favor of a foreign forum. This doctrine may apply whether there is actually a pending case in the foreign forum or not.

The lis alibi pendens doctrine permits a U.S. court to stay an action in deference to pending foreign litigation.

A third mechanism is an "antisuit injunction" which permits a U.S. court to enjoin a litigant from pursuing litigation in a foreign forum.

Another mechanism is to take no action and to allow the two actions to proceed at their own pace. The first final judgment would then be available to be plead as res judicata in the other forum.

Forum Non Conveniens

The origins of the doctrine of forum non conveniens as been described as "obscure" and "murky". Most commentators conclude that there is no evidence of the doctrine in Roman law or continental civil practice and instead point to the doctrine's original in Scottish common law decisions, where it first appeared in the late 1800's. The term forum non conveniens was apparently coined to distinguish discretionary dismissal based on convenience and comity from dismissal based upon a lack of judicial jurisdiction, where were terms "forum non competens."

One of the first U.S. cases showing acceptance of the doctrine of forum non conveniens was the U.S. Supreme Court decision in Canada Malting Co. v. Paterson SS Ltd., 285 U.S. 413 (1932), which involved a dispute between