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How to Prove a Loan was Done From the Business – By John R. Bullis, CPA

Another recent court case determined the documentation was missing to show money paid from the business to an owner was a loan.

The Tax Court looks at several items to decide if a bona fide loan occurred:

  1. Can the borrower repay (have ability and resources to repay)
  2. Does a debt instrument exist (is there a valid Promissory Note, etc)
  3. What security is offered, what interest rate applies and is there a repayment schedule
  4. Do the parties records and actions reflect the transaction to be a loan
  5. Did the borrower make any repayments
  6. Did the lender request or demand repayment
  7. Is it likely the loans were disguised pay for services and
  8. What testimony exists by the supposed borrower and lender.

When it is a case of unreported income, IRS has the initial burden of showing at least some evidence that the payment was income, not a loan.  If IRS has at least some evidence it is not a loan, the burden of proof shifts to the taxpayer.

The taxpayers involved did receive some wages and rents, but IRS found they received other checks that were not reported as income.   IRS determined they received unreported payments over three years of about $2,000,000.  The taxpayers gambled frequently.  They reported big winnings and claimed deductions for losses, but IRS found they did not report all of their winnings.

They gave IRS copies of canceled checks, some of which they altered by writing “loan” in the memo line and making similar alterations in the QuickBooks check registers.

The taxpayers argued that the amounts were loans and therefore not taxable income to them.

The Tax Court found they did not have ability to repay out of their current income; no promissory notes were done when the payments were made; no interest was charged and there was no schedule for repayment; their conduct and limited records indicated there was no intent of borrowing, there was no demand for repayment and their testimony was generally self-serving and lacked credibility.  There were no loans.  The amounts were taxable income.

The Court also assessed substantial penalties since the taxpayers did not show they acted reasonably and in good faith.

Did you hear “You fall the way you lean.”  Author unknown

John Bullis is a Certified Public Accountant and Certified Senior Advisor
He is the Founder Emeritus of Bullis & Company LLC
Contact him with questions at
775-882-4459

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