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from liability for the Northeast litigation and adversary
proceeding.
II. OPINION
A. Whether Petitioners May Deduct $750,000 That Petitioner Paid
To Settle Civil Litigation and Petitioner's Bankruptcy
Proceedings
1. Whether Petitioner's Settlement Payment Was a Business
Bad Debt
Petitioners contend that they may deduct as a business bad
debt or as a business expense $750,000 they paid in 1988 to
settle the Northeast litigation and petitioner's bankruptcy
proceedings.
A taxpayer may deduct debts that become worthless in the
taxable year. Sec. 166(a)(1). Section 166 distinguishes between
business and nonbusiness bad debts. A business bad debt is a
debt created or acquired in connection with the taxpayer's trade
or business or a debt the loss from the worthlessness of which is
incurred in the taxpayer's trade or business. Sec. 166(d)(2).
Nonbusiness bad debts of taxpayers other than corporations are
short-term capital losses. Sec. 166(d)(1)(B).
A taxpayer may deduct as a business bad debt a payment it
makes to discharge the taxpayer's obligation as a guarantor if:
(a) The taxpayer was engaged in a trade or business when he or
she made the guaranty, and (b) the guaranty was proximately
related to the conduct of that trade or business. Jones v.
Commissioner, T.C. Memo. 1997-368; Weber v. Commissioner, T.C.
Memo. 1994-341; Smartt v. Commissioner, T.C. Memo. 1993-65; see
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