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A tax refund of $3,653, the amount of Federal income tax withheld
from Schnell’s wages for the year, was requested by petitioners.
For each of the years in issue, the Schedule C for Barad
reflected zero gross receipts and zero cost of goods sold.
Therefore, petitioners did not report any gross income for Barad.
It was the practice of petitioners, over many years (including
the years in issue), to calculate and claim the amount of bad
debt necessary in order to arrive at zero taxable income and to
request a refund in the amount equal to Schnell’s Federal income
tax withholdings for that year. Petitioner did not consult any
tax professional regarding his tax returns.
OPINION
Bad Debt Deduction and Advertising and Office Expense Deductions
Section 166(a) allows a deduction for “any debt which
becomes worthless within the taxable year.” However, worthless
debts arising from unpaid wages, fees, and similar items of
taxable income are not deductible as a bad debt unless the
taxpayer has included the amount in income for the year for which
the bad debt is deducted or for a prior tax year. See Gertz v.
Commissioner, 64 T.C. 598, 600 (1975); sec. 1.166-1(e), Income
Tax Regs.; see also Prowse v. Commissioner, T.C. Memo. 2006-120;
Crosson v. Commissioner, T.C. Memo. 2003-170. “‘It is well
settled that a taxpayer is not allowed to reduce ordinary income
actually received by the amount of income he failed to receive.’”
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Last modified: May 25, 2011