For the Defense - Vol. 4, Issue 3 - 22
The bad debt deduction can only be taken when
your client can establish that the indemnification
right is worthless and uncollectible. The Treasury
Regulations provide that, when determining
whether a debt is "worthless" and therefore
eligible for a bad debt deduction, one should
consider all pertinent evidence, including the value
of the collateral securing the debt and the financial
condition of the debtor.15 For example, the criminal
investigation that ensnared your client could have
adversely affected his company's financial resources
and caused significant doubt as to whether the
company can meet its indemnification obligations.
Where the surrounding circumstances indicate that
a debt is worthless and uncollectible and that legal
action to enforce payment would in all probability
not result in the satisfaction of execution on a
judgment, the debt is deemed worthless and
eligible for a deduction.16
The Internal Revenue Service has allowed a bad
debt deduction for a worthless indemnification
right. The agency has ruled that: 1) a general
partner's state law right of contribution against a
22
For The Defense
l
Vol. 4, Issue 3
deceased partner created a bona fide debt for
section 166 purposes; and 2) because the deceased
partner's estate was insolvent at the time of the
general partner's payment, the general partner
could immediately deduct the worthless debt.17
The Internal Revenue Service could argue that
there is a public policy exception prohibiting
the bad debt deduction because the indemnity
claim relates to a non-deductible fine or penalty.
Indeed, one tax commentator has observed that
a public policy exception exists for illegal activity
such as drug deals.18 While there may be a public
policy concern, the clearer manifestation of
public policy can be found in the Pennsylvania
LLC Act, which prohibits indemnification only
where the act giving rise to indemnification is
determined by a court to constitute recklessness,
willful misconduct, or a knowing violation of
law.19 Your client may wish to file Form 8275,
Disclosure Statement, with his federal income tax
return to avoid the possibility of a penalty should
the Internal Revenue Service disagree with his
conclusion.20
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For the Defense - Vol. 4, Issue 3
Table of Contents for the Digital Edition of For the Defense - Vol. 4, Issue 3
Contents
For the Defense - Vol. 4, Issue 3 - 1
For the Defense - Vol. 4, Issue 3 - 2
For the Defense - Vol. 4, Issue 3 - Contents
For the Defense - Vol. 4, Issue 3 - 4
For the Defense - Vol. 4, Issue 3 - 5
For the Defense - Vol. 4, Issue 3 - 6
For the Defense - Vol. 4, Issue 3 - 7
For the Defense - Vol. 4, Issue 3 - 8
For the Defense - Vol. 4, Issue 3 - 9
For the Defense - Vol. 4, Issue 3 - 10
For the Defense - Vol. 4, Issue 3 - 11
For the Defense - Vol. 4, Issue 3 - 12
For the Defense - Vol. 4, Issue 3 - 13
For the Defense - Vol. 4, Issue 3 - 14
For the Defense - Vol. 4, Issue 3 - 15
For the Defense - Vol. 4, Issue 3 - 16
For the Defense - Vol. 4, Issue 3 - 17
For the Defense - Vol. 4, Issue 3 - 18
For the Defense - Vol. 4, Issue 3 - 19
For the Defense - Vol. 4, Issue 3 - 20
For the Defense - Vol. 4, Issue 3 - 21
For the Defense - Vol. 4, Issue 3 - 22
For the Defense - Vol. 4, Issue 3 - 23
For the Defense - Vol. 4, Issue 3 - 24
For the Defense - Vol. 4, Issue 3 - 25
For the Defense - Vol. 4, Issue 3 - 26
For the Defense - Vol. 4, Issue 3 - 27
For the Defense - Vol. 4, Issue 3 - 28
For the Defense - Vol. 4, Issue 3 - 29
For the Defense - Vol. 4, Issue 3 - 30
For the Defense - Vol. 4, Issue 3 - 31
For the Defense - Vol. 4, Issue 3 - 32
For the Defense - Vol. 4, Issue 3 - 33
For the Defense - Vol. 4, Issue 3 - 34
For the Defense - Vol. 4, Issue 3 - 35
For the Defense - Vol. 4, Issue 3 - 36
For the Defense - Vol. 4, Issue 3 - 37
For the Defense - Vol. 4, Issue 3 - 38
For the Defense - Vol. 4, Issue 3 - 39
For the Defense - Vol. 4, Issue 3 - 40
For the Defense - Vol. 4, Issue 3 - 41
For the Defense - Vol. 4, Issue 3 - 42
For the Defense - Vol. 4, Issue 3 - 43
For the Defense - Vol. 4, Issue 3 - 44
For the Defense - Vol. 4, Issue 3 - 45
For the Defense - Vol. 4, Issue 3 - 46
For the Defense - Vol. 4, Issue 3 - 47
For the Defense - Vol. 4, Issue 3 - 48
For the Defense - Vol. 4, Issue 3 - 49
For the Defense - Vol. 4, Issue 3 - 50
For the Defense - Vol. 4, Issue 3 - 51
For the Defense - Vol. 4, Issue 3 - 52
For the Defense - Vol. 4, Issue 3 - 53
For the Defense - Vol. 4, Issue 3 - 54
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