Academic journal article Journal of Accountancy

Loan Loss Held Not Personal

Academic journal article Journal of Accountancy

Loan Loss Held Not Personal

Article excerpt

The Tax Court ruled that a taxpayer's loan to a business associate was made in connection with the taxpayer's trade or business, and therefore, the forgiveness of that loan was a bad-debt loss under IRC [section] 166(a). The IRS had argued that the loan was personal and therefore subject to the limitations of section 1211.

During the years relevant to the case, Todd Dagres was a member manager of several limited liability companies that managed venture capital funds. At the same time, he was a salaried employee of Battery Management Co. (BMC), an S corporation that provided management services to the LLCs. Dagres' responsibilities as member manager included finding and researching investment opportunities for the venture capital funds.

Prior to this, Dagres had worked as an analyst for a San Francisco investment bank, focusing on the computer networking industry. In the mid-1990s, Dagres met William L. Schrader, whom Dagres considered a pioneer in the development of the Internet. Schrader's company, PSINet, provided Internet connectivity to commercial customers, and Dagres served as the lead investment banker for its initial public offering in 1995 and 1996. Schrader's contacts within the burgeoning Internet put him in a prime position to provide Dagres with leads on promising companies for Dagres to investigate as potential investments for the venture capital funds.

When the Internet stock bubble burst in 2000, PSINet'S share price fell by more than 85%, while the stock of many of the company's customers also plummeted, further eroding Schrader's financial position. Schrader's personal holdings of PSINet stock were pledged as collateral for loans, and his bankers began demanding additional security or repayment. After exhausting his personal funds and money he could obtain from family and friends, Schrader asked Dagres to lend him $5 million.

Dagres did so, with an unsecured demand note at 8% interest, in late 2000. In return, Schrader would tell Dagres about new companies that might provide Dagres, as member manager of the various capital venture funds, opportunities to profit from Schrader's industry knowledge and contacts. …

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