Is It Debt or Equity?

The 9^th 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”