Project Description

Regulations under Code Section 166 allow bad debt deductions for loan payments made that discharge a taxpayer’s obligation as a guarantor, reasoning that a guaranteed obligation is worthless when the guarantor pays the creditor. In Herrera v. Comm’r, the 5th Circuit disallowed a bad debt deduction for loan payments made by a consulting firm on behalf of a related-party manufacturing company. The bank loan used to fund the manufacturing business had been guaranteed by both the consulting firm and the manufacturing business, but was subsequently refinanced and only secured by the manufacturing business and not the consulting firm. For this reason, the loan payments made by the consulting firm were voluntary, not legally required, and not deductible under Treas. Reg. §1.166-9(d)(2). Additionally, there was no promissory note evidencing that the manufacturing business was indebted to the consulting firm, no maturity date, interest rate, nor any payments made.