Is It Debt or Equity?

The 9th Circuit Court of Appeals recently sided with the government in denying a taxpayer’s bad debt deduction for advances made to a company in which he was an officer and a shareholder.  In Ramig v. Comm, the Court citesits 1970 decision in A.R. Lantz Co., Inc. v. U.S. wherein guidelines were established for purposes of clarification as to exactly what constitutes a debt investment, as opposed to an equity investment, including:

  • Maturity dates are specified for ostensible “loans,” though principal was never paid and the dates were extended
  • “Notes” were not protected by collateral, an acceleration clause, or a sinking fund
  • “Noteholders” had a right to enforce payment, though there was considerable testimony that payment would not be enforced
  • There was a complete identity of interest between the parties
  • The “notes” were quickly subordinated by the only other creditor
  • Shareholders never received dividends but did receive irregular interest on their “notes”
  • The “notes” for the most part were in proportion to shareholdings
  • The trial court found that there was “…an atmosphere created by the testimony which indicates that all advances were treated in the same way”