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2. Bad Debt Deduction
Section 166 allows an individual a deduction from ordinary
income for any business debt that becomes wholly or partially
worthless during the taxable year. See sec. 166(a), (d)(1)(A).
To deduct a business bad debt, the taxpayer must establish, among
other requirements, that he was engaged in a trade or business,
and the acquisition or worthlessness of the debt was proximately
related to the conduct of the trade or business. United States
v. Generes, 405 U.S. 93 (1972); sec. 1.166-5(b)(2), Income Tax
Regs. For a debt to be considered a business debt, it must have
a proximate relation to the taxpayer’s trade or business. United
States v. Generes, supra at 96. In determining whether a
proximate relationship exists, the proper measure is the
taxpayer’s dominant motivation for incurring the debt. Id. at
103.
The term “nonbusiness debt” is defined as a debt other than
a debt created or acquired in connection with the taxpayer’s
trade or business or a loss from the worthlessness of a debt that
is incurred in the taxpayer’s trade or business. See sec.
166(d)(2). The loss from a nonbusiness bad debt that becomes
wholly worthless within the year is treated as a loss arising
from the sale or exchange of a capital asset held for less than 1
year and is deductible subject to certain limitations. See sec.
166(d)(1); sec. 1.166-5(a)(2), Income Tax Regs.
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Last modified: March 27, 2008