| |
You are here: Experts > Business > Corporate Law > Tax Law (Questions About Taxes) > default on a promissory note note tax deduction
Expert: MEdusa - 11/6/2009
Question
QUESTION:
FACTS:
My business partner and I are going our separate ways (very amicably). He is going to keep the business (residential drafting/architects), and I am going to move on back to the corporate world.
He still owes me money for various starts up cost, and cannot pay me. He has bad credit, and there is no chance he will get a loan.
I recommended that he gives me a promissory note for a yet to be determined amount ($90K-$110K), this reflects the “actual amount” owed, and can be documented.
If he does no pay me (very likely), he defaults and I would get a tax deduction (to recover a fraction of my loss)
Business type: LLC
Located: MN
In Business: six years
Is this a sound strategy?
What are the things to look out for?
I would like the options of the note going in default in 2010 or 2011 (depending on my tax rate), is this possible (do I make it a demand note?)?
THANK YOU
ANSWER: actually, you have a tax loss now. not in future years. just curious what the real amount is. and if you have a chance to get it right on your own. who prepared the LLC tax returns for the last six years?
first thing to look out for is a good cpa. winging it on a prayer and half assed is not a good idea.
let me re summarize...
you invested x dollars in llc. presume half. gives you outside basis in your investment
you made some money (increase in basis) and probably took out some money (decrease basis).
now, it is worthless. but you want your LLc co owner to give you a note that you think is worthless and he wont pay on. so the real story is that there is nothing left, so you walk away with a loss on your remaining basis in the investment.
did he not pay the same amount into the deal that you did? does he have negative capital with deficit restoration (beyond this class- email me for more). are there any assets left at all?
what is your basis now>? what do your k-1s look like for last 6 years?
not a simple answer to a very complicated question.
also, if you take a debt/note as distribution, the IRS could argue that was a distribution subject to tax now... and you pay tax NOW and then when it goes worthless, you get a $3k capital loss deduction later... for the rest of your life. bad outcome.
dont try this at home. important enough to get good and competent representation. where is your cpa?
MEdusa
---------- FOLLOW-UP ----------
QUESTION:
In a “nutshell” here is what happened. (the numbers listed are very close to actual)
Mark--$100K in start up expenses (equipment, working capital)
Tom---$zero
SIX YEARS LATER:
Mark took out cash $400K
Tom took out in cash $500K
MY VIEW OF THE WORLD:
Tom owes mark $100K (this is very close to the actual amount).
I want the cash, but if Tom defaults I assumed (maybe wrongly) that that was a $100K deductible loss for me.
The company is still going to operate (Tom 100% owner), but the “book assets” are $25K (street value $5K)
DOES THIS HELP.
ANSWER: actually, you are $150k behind.
how much income was reported in the interim (assumes 900k - the sum of the cash out)
have you been filing 1065 for the LLC for the 5 years? split income 50/50?
did the money all come out recently? or over time? why did it come out not pro rata?
so, you have 100 basis in, plus 450 (half of 900 income) is 550k basis. less the 400 you took out leaves you 150 basis. is your loss on the investment.
he has 0 in, plus 450 is 450, less 400 leaving a 50 defecit restoration (usually required under state law!) and he has gain on that 50k in the year you determine it to be worthless.
his failure to fund the defecit is likely a breach of state law.
also, when you leave, LLc ends as the partnership is over and has a technical termination (via the withdrawl of one partner).
so, as of now - the way i see it you have a $150k loss. and if he comes up with the $50k in cash (not note that would apparently have zero or near zero value) you recognize the income on that piece.. but you are down $150k now.. or $100k with his reimbursement of at least the defecit.
now, how about payroll over the last few years? proper withholding and reporting was taken care of? you have liability at the personal level for that. Sales taxes? is your service taxable in your jurisdiction?
email me direct via a private question with your contact information and i'll chat with you at greater length.
MEdusa
---------- FOLLOW-UP ----------
QUESTION:
I DON'T HAVE YOUR EMAIL ADDRESS
actually, you are $150k behind.
how much income was reported in the interim (assumes 900k - the sum of the cash out)
YES $900K OVER SIX YEARS AS NORMAL INCOME...
ALMOST NO CASH/10k IN AR, PC/SEVER/SOFTWARE/FURNITURE...WORTH VERY LITTLE STREET VALUE
have you been filing 1065 for the LLC for the 5 years? split income 50/50?
YES THE SPLIT WAS JUST ACTUAL AMOUNT TAKEN OUT...THE FIRST TWO YEARS HE TOOK MORE, THE LAST FOUR YEARS I HAVE TAKEN MORE OUT
did the money all come out recently? or over time? why did it come out not pro rata?
NO OVERTIME
so, you have 100 basis in, plus 450 (half of 900 income) is 550k basis. less the 400 you took out leaves you 150 basis. is your loss on the investment.
he has 0 in, plus 450 is 450, less 400 leaving a 50 defecit restoration (usually required under state law!) and he has gain on that 50k in the year you determine it to be worthless.
his failure to fund the defecit is likely a breach of state law.
EXPLAIN, IS THIS INCOME TO HIM
also, when you leave, LLc ends as the partnership is over and has a technical termination (via the withdrawl of one partner).
DO WE NEED TO REFILE?
so, as of now - the way i see it you have a $150k loss. and if he comes up with the $50k in cash (not note that would apparently have zero or near zero value) you recognize the income on that piece.. but you are down $150k now.. or $100k with his reimbursement of at least the defecit.
now, how about payroll over the last few years? proper withholding and reporting was taken care of? you have liability at the personal level for that. Sales taxes? is your service taxable in your jurisdiction? YES TO ALL
email me direct via a private question with your contact information and i'll chat with you at greater length.
MEdusa
Answer
send a NEW 'private' question and I'll provide email off line.
First, I would send him notice to demand the AR (and to the person who owes it too!)
assumes you have closed the LLC already? final return is required. no need to refile a re-do if this was a 2009 action (termination of partnership when you withdrew).
yes. he has income to the tune of his negative capital in the year of close just as you have loss on the positive capital.
more importantly, he is likely violating state law. the requirement to have defecit restoration is not only IRS but state partnership/LLC law. Probably opens him up to personal liability (and your ability to sue him personally for the debt (only the 50k part that is below water).
MEdusa
Add to this Answer Ask a Question
|
|
