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You are here: Experts > Business > Corporate Law > Tax Law (Questions About Taxes) > default on a promissory note note tax deduction
Expert: MEdusa - 11/4/2009
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
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