In Uncategorized on 10/06/2016 at 16:14

For Mary L. Hatcher, it was both. Though the $430K she parted with might have been for love, it wasn’t for business, and it didn’t go south in the right year, so Judge Lauber  dumps her bad debt deduction and NOL carryback in Mary L. Hatcher and Bradley J. Hatcher, 2016 T. C. Memo. 188, filed 10/6/16.

There was a note from her ex-boyfriend, but the parties hardly treated it in a businesslike way. Though they amended the note a couple times (hi, Judge Holmes), the ex never paid more than a tiny fraction of the interest (which Mary never reported), and finally threw in the cliché when he sent Mary an e-mail saying “I have no money.” 2016 T. C. Memo. 188, at p. 6.

Eventually Mary threw the note into her LLC (of which she was sole member and manager, and which she had formed the day before she threw in the note). The LLC did no business, and Judge Lauber concluded it was just window-dressing to try to give a business cover to her business bad debt claim.

Mary wasn’t in the loan business, she hadn’t checked out ex’s ability to pay, creditworthiness, or anything else. And Mary had an MBA in corporate finance (from which school not stated).

Anyway, she sued her ex on the note the year after she claimed it had become worthless, got a judgment the next year and tried post-judgment discovery (what we used to call a supp pro) and negotiations with ex into the year after that. Nobody wastes time and money chasing a worthless debtor, says Judge Lauber.

Judge, I’m going to suggest that it might could be that the heart has its reasons, even when the wallet does not. But that’s not enough to unworthify a note. For tax reasons, anyway.

Brad claimed to be a real estate pro, and he had originated mortgage loans in the past (but not in the year at issue), and his own testimony shows only 450 hours, short of the magic 750.

Mary claims a big NOL based on the worthless note and tries a carryback thereof. This gets her a 20% substantial understatement chop.

“In the case of an NOL carryback, the penalty for negligence applies to any portion of an underpayment for the carryback year that is attributable to negligence in the year in which the NOL arose (loss year).  Sec. 1.6662-3(d)(1), Income Tax Regs.  Similarly, the substantial understatement penalty applies to any portion of an underpayment in the carryback year that is attributable to a ‘tainted item’ in the loss year.  Sec. 1.6662-4(c)(1), Income Tax Regs.  The determination of whether an understatement is ‘substantial’ for a carryback year is made with respect to the return for that year.  Ibid.  A ‘tainted item’ is any item for which there is neither substantial authority nor adequate disclosure with respect to the loss year.  Id. subpara. (3)(i).” 2016 T. C. Memo. 188, at p. 22.

MBA Mary flunks the five-and-ten test (greater of $5K or 10% of tax due) for her NOL because her claimed bad debt is clearly tainted; she prepared her own returns, and the IRS pub she relies on tells her to look at another pub, that she didn’t rely on.

But Brad escapes in part on his real estate; he lost his Sched E $25K substantial participation deduction and got penalized on the SE arising therefrom only because of Mary’s bad debt shenanigans. So Brad’s deduction gets saved from the 20% understatement chop.


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