(a) Noncorporate obligations—(1) Deductible as bad debt. A payment during the taxable year by a taxpayer other than a corporation in discharge of part or all of his obligation as a guarantor, endorser, or indemnitor of an obligation issued by a person other than a corporation shall, for purposes of section 166 and the regulations thereunder, be treated as a debt's becoming worthless within the taxable year, if—
(i) The proceeds of the obligation so issued have been used in the trade or business of the borrower, and
(ii) The borrower's obligation to the person to whom the taxpayer's payment is made is worthless at the time of payment except for the existence of the guaranty, endorsement, or indemnity, whether or not such obligation has in fact become worthless within the taxable year in which payment is made.
(2) Nonbusiness debt rule not applicable. If a payment is treated as a loss in accordance with the provisions of subparagraph (1) of this paragraph, section 166(d), relating to the special rule for losses sustained on the worthlessness of a nonbusiness debt, shall not apply. Accordingly, in each instance the loss shall be deducted under section 166(a)(1) as a wholly worthless debt even though there has been a discharge of only a part of the taxpayer's obligation. Thus, if the taxpayer makes a payment during the taxable year in discharge of only part of his obligation as a guarantor, endorser, or indemnitor, he may treat such payment under section 166(a)(1) as a debt's becoming wholly worthless within the taxable year, provided that he can establish that such part of the borrower's obligation to the person to whom the taxpayer's payment is made is worthless at the time of payment and the conditions of subparagraph (1) of this paragraph have otherwise been satisfied.
(3) Other applicable provisions. Other provisions of the internal revenue laws relating to bad debts, such as section 111, relating to the recovery of bad debts, shall be deemed to apply to any payment which, under the provisions of this paragraph, is treated as a bad debt. If the requirements of section 166(f) are not met, any loss sustained by a guarantor, endorser, or indemnitor upon the worthlessness of the debtor's obligation shall be treated under the provisions of law applicable thereto. See, for example, paragraph (b) of this section.
(b) Corporate obligations. The loss sustained during the taxable year by a taxpayer other than a corporation in discharge of all of his obligation as a guarantor of an obligation issued by a corporation shall be treated, in accordance with section 166(d) and the regulations thereunder, as a loss sustained on the worthlessness of a nonbusiness debt if the debt created in the guarantor's favor as a result of the payment does not come within the exceptions prescribed by section 166(d)(2) (A) or (B). See paragraph (a)(2) of § 1.166-5.
(c) Examples. The application of this section may be illustrated by the following examples:
Example 1.During 1955, A, an individual who makes his return on the basis of the calendar year, guarantees payment of an obligation of B, an individual, to the X Bank, the proceeds of the obligation being used in B's business. B defaults on his obligation in 1956. A makes payment to the X Bank during 1957 in discharge of his entire obligation as a guarantor, the obligation of B to the X Bank being wholly worthless. For his taxable year 1957, A is entitled to a deduction under section 166(a)(1) as a result of his payment during that year.Example 2.During 1955, A, an individual who makes his return on the basis of the calendar year, guarantees payment of an obligation of B, an individual, to the X Bank, the proceeds of the obligation being used in B's business. In 1956, B pays a part of his obligation to the X Bank but defaults on the remaining part. In 1957, A makes payment to the X Bank, in discharge of part of his obligation as a guarantor, of the remaining unpaid part of B's obligation to the bank, such part of B's obligation then being worthless. For his taxable year 1957, A is entitled to a deduction under section 166(a) (1) as a result of his payment of the remaining unpaid part of B's obligation.Example 3.During 1955, A, an individual who makes his return on the basis of the calendar year, guarantees payment of an obligation of B, an individual, to the X Bank, the proceeds of the obligation being used for B's personal use. B defaults on his obligation in 1956. A makes payment to the X Bank during 1957 in discharge of his entire obligation as a guarantor, the obligation of B to X Bank being wholly worthless. A may not apply the benefit of section 166(f) to his loss, since the proceeds of B's obligation have not been used in B's trade or business.Example 4.During 1955, A, an individual who makes his return on the basis of the calendar year, guarantees payment of an obligation of Y Corporation to the X Bank, the proceeds of the obligation being used in Y Corporation's business. Y Corporation defaults on its obligation in 1956. A makes payment to the X Bank during 1957 in discharge of his entire obligation as a guarantor, the obligation of Y Corporation to the X Bank being wholly worthless. At no time during 1955 or 1957 is A engaged in a trade or business. For his taxable year 1957, A is entitled to deduct a capital loss in accordance with the provisions of section 166(d) and paragraph (a) (2) of § 1.166-5. He may not apply the benefit of section 166(f) to his loss, since his payment is in discharge of an obligation issued by a corporation.(d) Effective date. This section applies only to losses, regardless of the taxable year in which incurred, on agreements made before January 1, 1976.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 7657, 44 FR 68464, Nov. 29, 1979]
Notes of Decisions
Cited in
29
cases, 1962–1997 · leading case:
Scifo v. Comm'r, 68 T.C. 714 (Tax Ct. 1977).
Scifo v. Comm'r, 68 T.C. 714 (Tax Ct. 1977).
· cites it 4× “166(d)(1) was amended Oct. 4, 1976, by sec. 1402(b)(1) of Pub. L. 94-455.”
Benak v. Comm'r, 77 T.C. 1213 (Tax Ct. 1981).
· cites it 4× “He testified that he had made loans to six other small businesses, but he was unable to substantiate any of such loans. Moreover, the petitioners' tax return for 1974 failed to reflect that they were deriving any income from any such investments.”
Andrew v. Comm'r, 54 T.C. 239 (Tax Ct. 1970).
· cites it 2× “03a at 20-21 (1969 rev.). There is no question as to the first two requirements, since, of course, neither the payors *238 (petitioners) nor the primary obligors (Boyd and Jerry) were a corporation.”
Tolzman v. Comm'r, 43 T.C.M. 1 (Tax Ct. 1981).
· cites it 4× “Both are determined under section 166, I.R.”
La Staiti v. Comm'r, 41 T.C.M. 511 (Tax Ct. 1980).
· cites it 2× “However, if the loss incurred as a result of the worthlessness of the corporation's obligation to repay the guarantor was incurred in connection with the guarantor's trade or business, payments in satisfaction of the guarantee are fully deductible business bad debts.”
Est. of Allen v. Comm'r, 44 T.C.M. 9 (Tax Ct. 1982).
· cites it 2× “The rules for determining whether a direct loan gives rise to a business or nonbusiness debt apply equally to debts which guarantors acquire by subrogation. Putnam v. Commissioner, 352 U.”
Baker v. Comm'r, 41 T.C.M. 1142 (Tax Ct. 1981).
· cites it 2× “82 (1956) ; section 1.166-8(b), Income Tax Regs.”
Louismet v. Comm'r, 43 T.C.M. 1496 (Tax Ct. 1982).
· cites it 4× “However, no evidence was adduced to show when such bankruptcy occurred or that the note actually was worthless. Nevertheless, we consider respondent's failure to raise these issues as concessions that the payment on the guaranty constituted a worthless debt in 1974 within the…”
Taylor v. Comm'r, 57 T.C.M. 895 (Tax Ct. 1989).
· cites it 8× “166-8, Income Tax Regs. Respondent contends that (1) Associates was not in a *347 trade or business and petitioners' personal use of part of the proceeds of the Associates loan shows that the predominant motive of their guaranty of that loan was not connected with a trade or…”
Axelrod v. Comm'r, 37 T.C. 1053 (Tax Ct. 1962).
· cites it 2× “); nor is any real light shed on the meaning of the phrase or the purpose of the provision by the Senate Finance Committee in its report.”
Brooks v. Comm'r, 59 T.C.M. 682 (Tax Ct. 1990).
· cites it 8× “Losses sustained as a result of discharging liability as a guarantor of corporate obligations may, in some cases, be deductible as business bad debts or as nonbusiness bad debts.”
Fegan v. Comm'r, 44 T.C.M. 636 (Tax Ct. 1982).
· cites it 4× “Although the debt between the third party and the taxpayer does not arise until the taxpayer actually pays the creditor because of the guarantee, the characterization of the debt is based upon the facts as of the time when the guarantee was initially given.”
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