Business Loans

Today Michael from Tacoma, WA says, “I loaned money to a friend’s business. Can I deduct some of the loss of the business? I know if I received a profit from it I would have to claim and pay. If so do you know what tax form and/or line I enter it?”

Dear Michael,

Well, that was nice of you.

If you lend a friend money, you need to have a formal, signed ‘note’ from your friend, showing how much you lent, the interest rate and repayment terms. Do you have that?

Or, did you ‘invest’ the money with your friend, so you would own a share of the business and the profits, if he had succeeded? Again, it helps to have written paperwork describing your arrangement.

These are two different things to IRS, even if they look the same to you.

If you had a loan, yes, you would have paid tax on the INTEREST income you would have received.

If you had an investment, you would have paid tax on your share of the profits or dividends, depending on what form of business he’d set up (partnership, LLC, corporation, S-Corp).

He should have sent you a Schedule K-1 if it was a partnership, LLC or S-Corp. If it’s a regular corporation, you only report the income – IF you get dividends. Losses don’t flow through to you.

If it’s just his personal business (he files it on his Schedule C) and promises to give you a share of the profits, well…you don’t get a share of the losses.

So, if you had a LOAN, first, you have to prove it was not collectible. Did you try to collect the money from your friend? That means sending written requests for payment, perhaps even to the point of taking him to court to pay you.

If you didn’t, and your friend has assets, but you just decided to let it go because you didn’t want to ruin a good friendship – you just gave him a gift. (And that opens up a WHOLE other series of tax issues.) You can’t deduct gifts.

I really recommend that you sit down with a good tax pro to sort this all out properly.

And you thought this was a quickie answer?

And remember, you can find answers to all kinds of questions about bad debts and all kinds of other tax issues, free. Where? Where else? At TaxMama.com

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