26 C.F.R. § 1.166-9

Losses of guarantors, endorsers, and indemnitors incurred, on agreements made after December 31, 1975, in taxable years beginning after such date

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(a) Payment treated as worthless business debt. This paragraph applies to taxpayers who, after December 31, 1975, enter into an agreement in the course of their trade or business to act as (or in a manner essentially equivalent to) a guarantor, endorser, or indemnitor of (or other secondary obligor upon) a debt obligation. Subject to the provisions of paragraphs (c), (d), and (e) of this section, a payment of principal or interest made during a taxable year beginning after December 31, 1975, by the taxpayer in discharge of part or all of the taxpayer's obligation as a guarantor, endorser, or indemnitor is treated as a business debt becoming worthless in the taxable year in which the payment is made or in the taxable year described in paragraph (e)(2) of this section. Neither section 163 (relating to interest) nor section 165 (relating to losses) shall apply with respect to such a payment.

(b) Payment treated as worthless nonbusiness debt. This paragraph applies to taxpayers (other than corporations) who, after December 31, 1975, enter into a transaction for profit, but not in the course of their trade or business, to act as (or in a manner essentially equivalent to) a guarantor, endorser, or indemnitor of (or other secondary obligor upon) a debt obligation. Subject to the provisions of paragraphs (c), (d), and (e) of this section, a payment of principal or interest made during a taxable year beginning after December 31, 1975, by the taxpayer in discharge of part or all of the taxpayer's obligation as a guarantor, endorser, or indemnitor is treated as a worthless nonbusiness debt in the taxable year in which the payment is made or in the taxable year described in paragraph (e)(2) of this section. Neither section 163 nor section 165 shall apply with respect to such a payment.

(c) Obligations issued by corporations. No treatment as a worthless debt is allowed with respect to a payment made by the taxpayer in discharge of part or all of the taxpayer's obligation as a guarantor, endorser, or indemnitor of an obligation issued by a corporation if, on the basis of the facts and circumstances at the time the obligation was entered into, the payment constitutes a contribution to capital by a shareholder. The rule of this paragraph (c) applies to payments whenever made (see paragraph (f) of this section).

(d) Certain payments treated as worthless debts. A payment in discharge of part or all of taxpayer's agreement to act as guarantor, endorser, or indemnitor of an obligation is to be treated as a worthless debt only if—

(1) The agreement was entered into in the course of the taxpayer's trade or business or a transaction for profit;

(2) There was an enforceable legal duty upon the taxpayer to make the payment (except that legal action need not have been brought against the taxpayer); and

(3) The agreement was entered into before the obligation became worthless (or partially worthless in the case of an agreement entered into in the course of the taxpayer's trade or business). See §§ 1.166-2 and 1.166-3 for rules on worthless and partially worthless debts. For purposes of this paragraph (d)(3), an agreement is considered as entered into before the obligation became worthless (or partially worthless) if there was a reasonable expectation on the part of the taxpayer at the time the agreement was entered into that the taxpayer would not be called upon to pay the debt (subject to such agreement) without full reimbursement from the issuer of the obligation.

(e) Special rules—(1) Reasonable consideration required. Treatment as a worthless debt of a payment made by a taxpayer in discharge of part or all of the taxpayer's agreement to act as a guarantor, endorser, or indemnitor of an obligation is allowed only if the taxpayer demonstrates that reasonable consideration was received for entering into the agreement. For purposes of this paragraph (e)(1), reasonable consideration is not limited to direct consideration in the form of cash or property. Thus, where a taxpayer can demonstrate that the agreement was given without direct consideration in the form of cash or property but in accordance with normal business practice or for a good faith business purpose, worthless debt treatment is allowed with respect to a payment in discharge of part or all of the agreement if the conditions of this section are met. However, consideration received from a taxpayer's spouse or any individual listed in section 152(a) must be direct consideration in the form of cash or property.

(2) Right of subrogation. With respect to a payment made by a taxpayer in discharge of part or all of the taxpayer's agreement to act as a guarantor, endorser, or indemnitor where the agreement provides for a right of subrogation or other similar right against the issuer, treatment as a worthless debt is not allowed until the taxable year in which the right of subrogation or other similar right becomes totally worthless (or partially worthless in the case of an agreement which arose in the course of the taxpayer's trade or business).

(3) Other applicable provisions. Unless inconsistent with this section, other Internal Revenue laws concerning worthless debts, such as section 111 relating to the recovery of bad debts, apply to any payment which, under the provisions of this section, is treated as giving rise to a worthless debt.

(4) Taxpayer defined. For purposes of this section, except as otherwise provided, the term “taxpayer” means any taxpayer and includes individuals, corporations, partnerships, trusts and estates.

(f) Effective date. This section applies to losses incurred on agreements made after December 31, 1975, in taxable years beginning after such date. However, paragraph (c) of this section also applies to payments, regardless of the taxable year in which made, under agreements made before January 1, 1976.

[T.D. 7657, 44 FR 68465, Nov. 29, 1979, as amended by T.D. 7920, 48 FR 50712, Nov. 3, 1983]

Notes of Decisions

Cited in 48 cases, 1980–2020 · leading case: Lair v. Comm'r, 95 T.C. 484 (Tax Ct. 1990).

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Lair v. Comm'r, 95 T.C. 484 (Tax Ct. 1990). · cites it 50× “, precludes the deduction since T received neither cash nor property as consideration for the guarantee from his son.”

Intergraph Corp. v. Comm'r, 106 T.C. 312 (Tax Ct. 1996). · cites it 22× “Where a guarantor has a right of subrogation against, or a right of reimbursement from, the primary obligor (regardless of whether that right is expressly stated in the guaranty agreement), the provisions of sec.”

Black Gold Energy Corp. v. Comm'r, 99 T.C. 482 (Tax Ct. 1992). · cites it 14× “166(a). Losses of guarantors are subject to particular conditions of deductibility.”

Perry v. Comm'r, 92 T.C. 470 (Tax Ct. 1989). · cites it 6× “, as authority for the use of a guaranty as a basis for the nonbusiness bad debt deduction.”

Lowe's Home Ctrs., LLC v. Dep't of Revenue, 455 P.3d 659 (Wash. 2020). · cites it 5× “The parties do not disagree. No. 96383-5 business or transaction for profit, the taxpayer was subject to an enforceable legal duty to make the payment, and the agreement was entered into before the obligation became worthless.”

Parekh v. Comm'r, 1998 T.C. Memo. 151 (Tax Ct. 1998). · cites it 6× “Respondent contends that the amount paid on the guaranty is a nonbusiness bad debt, which is deductible only as a short-term capital loss under section 166(d) and section 1.”

Ramig v. Comm'r, 2011 T.C. Memo. 147 (Tax Ct. 2011). · cites it 6× “Ramig paid Puget Sound Leasing $2,500 between December 2002 and May 2005.”

Clanton v. Comm'r, 70 T.C.M. 534 (Tax Ct. 1995). · cites it 10× “In her notice of deficiency, respondent disallowed the losses on the grounds that: (1) Petitioner's payment of the State National note did not create a bona fide debt; (2) petitioner's payment of the Jersey Village note in discharge of his guarantee is subject to the rules under…”

In Re St. Johnsbury Trucking Co. Inc., 206 B.R. 318 (Bankr. S.D.N.Y. 1997). “Debtor argues that it fits under 26 CFR § 1.166-9 because it began paying Bankers Trust to discharge its obligation as a guarantor.”

Lowe's Home Centers, Llc v. Dept. Of Revenue, State Of Wa, 425 P.3d 959 (Wash. Ct. App. 2018). · cites it 11× “Here, the DOR agrees that Lowe’s profit-sharing reductions qualified as federal bad debts arising from a guarantor loss under 26 C.F.R. § 1.166-9 (a). Wash. Court of Appeals oral argument, Lowe’s Home Centers, LLC, v.”

La Staiti v. Comm'r, 41 T.C.M. 511 (Tax Ct. 1980). · cites it 2× “No deduction is allowed the guarantor of a corpoirate obligation if, considering the circumstances as of the time of the creation of the guarantee obligation, the payment in satisfaction of the guarantee is in fact a shareholder contribution of capital to the corporation.”

Est. of Allen v. Comm'r, 44 T.C.M. 9 (Tax Ct. 1982). · cites it 2× “Respondent does not challenge the bona fides of the debts petitioner acquired by subrogation as a result of his discharge of the guaranties.”

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— 26 C.F.R. § 1.166-9(a) — 1 case

Lowe's Home Ctrs., LLC v. Dep't of Revenue, 455 P.3d 659 (Wash. 2020). “The parties do not disagree. No. 96383-5 business or transaction for profit, the taxpayer was subject to an enforceable legal duty to make the payment, and the agreement was entered into before the obligation became worthless.”

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