Employee-stockholder's unpaid loan balance.

• Author: Mirpuri, Shashi L.

Whether a taxpayer can claim a business bad debt or a nonbusiness bad debt is particularly important and can lead to a different result on the tax return. Under Sec. 166, a bona fide business bad debt may be deducted during the year in which it becomes worthless. By contrast, a nonbusiness bad debt is not deductible and is treated as a short-term capital loss. In a recent case, Haury, T.C. Memo. 2012215, the Tax Court held that a loss is a nonbusiness bad debt where a taxpayer's dominant motive is to protect his investment in a corporation, even if the taxpayer is an employee.

Haury was an engineer who developed software and licensed it to NuParadigm Government Systems Inc. (NPGS) and NPS Systems Inc. (NPS), two information system companies for which he provided technical advice and strategic direction. During 2007, he was the CEO and owned 48.3% of NPGS and was the president, secretary, and sole board member of NPS, of which he owned 49.2%.

In late 2006, NPGS and NPS were involved in a subcontract agreement in trying to assist in the development of a national alert warning system software, and the companies incurred approximately $4 million of development costs. In 2007, to improve cash flow, Haury transferred $434,933 to the companies from his IRA and executed interest-bearing promissory notes that required the companies to repay Haury on demand. To loan the money to the companies, Haury withdrew from his IRA the amounts of $120,000, $168,000, $100,000, and $46,933 on Feb. 15, April 9, May 14, and July 6, respectively. On April 30, 2007, the IRA trustees received and deposited into Haury's account a $120,000 check from NPGS.

Subsequently, a private investor loaned $500,000 to NPGS but conditioned it on Haury's agreement to subordinate his repayment rights. This note provided for monthly interest payments and was payable in full on demand.

In December 2007, the deal fell through, and Haury demanded that the companies repay the funds transferred from his IRA. NPGS and NPS refused his demands and insisted that the companies could not repay. After 2007, Haury received no form of compensation from the companies.

In February 2010, the IRS prepared a substitute for return relating to Haury's 2007 tax year and on May 10, 2010, sent him a statutory notice of deficiency. The IRS determined that Haury had a tax liability relating to wage income of $149,216; a $434,964 early withdrawal from an IRA; and penalties for failure to file a tax return...