Howard S. Bugbee v. Commissioner
34 T.C.M. 291 (Tax Ct. 1975)
Bugbee was friends with
Billings. They talked about various business ventures, and over the years
Bugbee gave Billings loans of almost $20k to investigate business
prospects. But Billings was a deadbeat who never followed through on any
prospects and never repaid the money.
Bugbee had IOUs from
Billings claiming that he'd repay with interest, but he never did.
When he filed his taxes,
Bugbee reported the $20k as a short-term capital loss (under 26 U.S.C. §166), and used
it to offset some capital gains he had that year.
The IRS denied the claim.
The IRS argued that Bugbee
hadn't established that the money he gave Billings was a loan, it could
have just been a gift. In addition, since the 'loans' were unsecured,
Bugbee did not have an expectation that he would be repaid.
In order to count as a bad
debt short-term capital loss,
Bugbee would have to show evidence that he was in a debtor-creditor
relationship with Billings.
The Tax Court found for Bugbee
and allowed him to claim the short-term capital loss.
The Tax Court noted that to
qualify under §166 there must
first be a bona fide debt that arises from a debtor-creditor relationship
upon a valid and enforceable obligation to pay a fixed and determinable
sum of money.
Basically, the Court weighed
the evidence and found that although Bugbee was friends with Billings,
and Billings was objectively unlikely to ever pay him back, Bugbee
subjectively believed that he would be paid back.
Therefore, Bugbee satisfied
the condition that a debtor-creditor relationship had been established.