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| Promissory Notes |
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The other day, I was watching the Suze Orman show when she told a listener whose brother refused to pay off a promissory note of $6,000 to write off the borrowed money from his income taxes as a bad debt. However she added that it’s up to the brother to claim the money as an income.
My question is this: “What would happen to the brother if he doesn’t claim the money as income and gets audited by the IRS in the future? And what can he do to protect himself in the future?”
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Thu Nov 18, 2004 3:25 pm |
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BlankenshipFP
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If the promissory note is documented - that is, if it is an actual document and not a verbal agreement - then the brother claiming the bad debt deduction has to show proof of the transaction and his brother's refusal to pay.
When the IRS sees this, (in theory) they'll look for the corresponding entry on the debtor brother's return. When they don't find it, they'll come to him looking for it.
If the facts are legitimate in the case, there is nothing that the debtor brother can do to protect himself against this happening. In other words, he is obligated to claim the debt that he refuses to repay as income.
Hope this helps -
Jim Blankenship, CFP®, EA
Blankenship Financial Planning, Ltd.
www.BlankenshipFinancial.com
Standard IRS Circular 230 Notice Applies
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Thu Nov 18, 2004 4:30 pm |
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Capitalist
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Thank you so much for your answer.
Your reply draws another question. So to be able to claim the debt as a financial loss and write it off as bad debt, the lender must show proof that his brother refuses to pay the debt. Am I wrong? How can he provide such proof?
In addition, what would happen if the debtor brother doesn't claim the debt as an income and gets audited? Can he claim it then?
The reason why I am asking these questions, is because I am in a similar situation. My ex-fiancée lent me some money for which I wrote her a promissory note. When we broke up, she told me to forget about the money. In her own words, she said it was a gift. Unfortunately she never gave me the promissory note back. And since she is a CPA, I am wondering if she has other plans regarding this debt. In my mind, I still owe her the money. Believe me, If I could pay it now, I would. I know how she thinks: she counts every dollar and I know she will never forget about this debt. For example, she made me write the promissory note with a return rate of 10%.
What would you do if you were me? How do I find out if she claimed the money as a bad debt without asking her? And if she did and I didn't claim it as income because I didn't know, am I still liable according to the IRS?
Thank you so much for your help. I really appreciate it.
Capitalist
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Mon Nov 22, 2004 5:10 pm |
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BlankenshipFP
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As long as she can prove that she has taken steps to collect the debt, such as letters, judgement, etc., then that can be used as proof that the debt is uncollectible.
You need to write down the specifics of the situation, in case it should come up later on, when you might have trouble remembering.
If she specifically said that the money was a "gift", then you should have no problem - gifted amounts are not considered income for taxing purposes.
In the meantime, assuming that you are intending to pay her back, I'd say you should get in touch with her and set up a repayment schedule - whatever you can afford, even if it's only $5 a month to start.
You might also try to talk her into re-writing the promissory note (since she said to just forget about it) with one that carries no interest, or something more reasonable. It's worth a try.
Or, you could just sit back and forget the whole thing - depends upon your attitude, how painful it would be to have to discuss this with the ex, and the amount of money in question.
Hope this helps -
Jim Blankenship, CFP®, EA
Blankenship Financial Planning, Ltd.
www.BlankenshipFinancial.com
Standard IRS Circular 230 Notice Applies
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Mon Nov 22, 2004 6:33 pm |
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Capitalist
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 It did help a lot. Thanks a lot my friend. I feel more confortable now. FYI, I will pay her back. I am starting a new venture investing in Real Estate, and depending on how well I do, I should be able to pay her back, including the accumulated interest within a year. It will make me feel good about myself. It's a question of principle. So I will give her the money in one lump sum. But then sending her checks from time to time is not a bad idea as you have suggested.
The problem is how can I record these transactions as debt payments? I have no problem paying Interest, because I accepted the debt with all its terms and conditions. So it is my responsibility.
Again thank you for your answer and valuable time.
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Tue Nov 23, 2004 6:00 am |
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BlankenshipFP
Money Talk Advisor
Cash: $ 79.56
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Location: Illinois
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It may not hold a lot of water in court, but if you put a notation in the memo field of your check to indicate that this is payment toward principal and interest on this personal loan, it should help matters.
I'd suggest talking to her about it - so that she knows your plans. Unfortunately, too many times we avoid the confrontation with our creditors when just a little communication can resolve differences and smooth the relationship.
I wish you well -
Jim Blankenship, CFP®, EA
Blankenship Financial Planning, Ltd.
www.BlankenshipFinancial.com
Standard IRS Circular 230 Notice Applies
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Tue Nov 23, 2004 12:23 pm |
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