Taxpayer Can't Deduct Repayment to Mother for Unauthorized Stock Purchases.
(Parker Tax Publishing May 2, 2014)

A businessman could not claim a nonbusiness bad debt deduction for funds transferred to two trusts established for the benefit of his children; nor was he entitled to business loss deductions for amounts paid pursuant to a purported indemnification agreement with his mother to compensate her for losses resulting from his unauthorized stock purchases on her behalf. Alpert v. Comm'r, T.C. Memo. 2014-70 (4/17/14).

Robert Alpert, an entrepreneur and philanthropist, operated numerous business enterprises under the name "The Alpert Companies." In 1990, Robert established two irrevocable trusts to benefit his sons, Roman and Daniel. The trust agreements for the two trusts were substantially the same and allowed the trustee to appoint a successor trustee. Each trustee was either Robert's friend, relative, or employee. From 1995 to 2000, Robert transferred over $4 million to the two trusts. During the same time period, the trusts transferred almost $4 million to Robert to expend on behalf of the trusts. In 1996, the trustee for the trusts signed two promissory notes claiming to document loans from Robert to the trusts, which provided an interest rate, payment terms, and collateral for the notes. No funds were actually transferred to either trust in connection with the promissory notes. Rather, the amounts stated as transferred approximated the net funds Robert had previously advanced to each trust. At that time, Robert created a third trust for the benefit of his sons. In 1999, the trustee filed suit against Robert for interference with his duties as trustee. A probate court entered judgments in favor of the trusts.

In 1997, Robert, who had trading authority over his mother's brokerage accounts, acquired on her behalf thousands of shares in one of his companies, Aviation Sales Company (AVS). Gladys sold all the shares for a loss. In 2000, acting without her knowledge, Robert acquired additional AVS shares for Gladys. After Gladys threatened litigation when she learned of the unauthorized purchases, Robert agreed orally, and confirmed in a letter, that he would indemnify her for any losses incurred if the shares were sold at a loss. Gladys agreed to equally share any profits if the shares were sold at a gain. When the remaining shares were sold at loss in 2006, Robert sent Gladys a series of letters claiming he had fulfilled his obligation under their agreement to indemnify her for her losses.

On Schedules D, Capital Gains and Losses, of his 2006 tax return, Robert reported short-term capital losses for worthless debts he said were owed to him by the two trusts. He also claimed short-term capital losses in connection with the indemnification agreement with his mother, characterizing such losses as trade or business losses The IRS disallowed the deductions and determined that Robert was liable for an accuracy-related penalty. The IRS contended that Robert did not show that the transfers were bona fide debts and, even if they were bona fide debts, Robert did not show that he was a debt holder and the debts became worthless.

Code Sec. 166 allows a deduction for any debt that becomes worthless within the tax year. In the case of an individual, a nonbusiness bad debt that becomes worthless during the year may be deducted, but only as a short-term capital loss. A bona fide debt is a debt that arises from debtor-creditor relationship based on a valid and enforceable obligation to pay a fixed sum of money under Reg. Sec. 1.166-1(c). Code Sec. 165 allows a deduction for losses sustained within the tax year that are not compensated for insurance. For individuals, the deduction is limited to losses incurred in a trade or business.

The Tax Court held that Robert's transfers to the two trusts were not bona fide loans. The court noted that the only evidence of the claimed loans were the two promissory notes executed by the trustee. No actual transfers of funds occurred in conjunction with the notes; rather, the notes merely reflected cumulative funds Robert had transferred to the trusts as of the date of the notes. With respect to funds transferred after that date, there was no documentation at all, and no provision for security, interest rate, repayment schedule or evidence of a demand for repayment.

The court also concluded that Robert's losses from the indemnification agreement with his mother were not in connection with his trade or business. Robert failed to show that his efforts to protect himself from liability for engaging in unauthorized transactions or that his management of his mother's assets constituted part of his trade or business.

Finally, the court upheld the IRS's imposition of an accuracy-related penalty. Although Robert's return was prepared by a professional tax preparer, he failed to show that he provided the necessary and accurate information to properly prepare his return or that he relied on his preparer's advice in good faith.

For a discussion of the general rules for a bad debt deduction, see Parker Tax ¶98,401. (Staff Editor Parker Tax Publishing)

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