Can a bankrupt single member LLC show the settlement charges in Schedule C in Form 1040 as sole proprietor?

[upcomingcpa19]

- LLC was created 3 years back
- no income generated, no expenses- never reported in personal tax return
- Was to invest in a company and had $500,000 bank note to be paid to that company
- the other company was a fraud, lawsuit begins with case filed by other company
- LLC’s single member pays $50,000 from his own pocket as settlement money in court in 2018
- the LLC’s member then files bankruptcy too and closes LLC
- can member claim the settlement charges in his 2018 Federal and State return as a tax deduction?

If yes, how. Kindly advise. Thanks in advance

 

[FlyingRon]

You're going to have to explain:

1. What type of bankruptcy.
2. What "settlement" fees you are talking about.

Money paid to settle debts aren't deductible. Certain things like legal/trustee fees MIGHT be

 

[Taxing Matters]

So the LLC owner was sued and settled the matter for $50,000. Whether there is any deduction for that depends on what the origin of the claim was — in more plain English, what was it that the other party claimed the LLC owner did that resulted in the lawsuit being filed?

Money paid to settle debts aren't deductible.

Some debts you pay you do indeed get to deduct. You cannot deduct repayment of loans you took out, but there are all kinds of debts besides loans.

 

[upcomingcpa19]

Thanks for the replies. Yes, I was able to gather more info in this case. Seems there was a parent company with many LLCs falling under it. My client was a single member in one of the individual LLCs. The parent company took out a note of $500,000 on behalf of each of the individual LLCs and spent the notes. My client was held liable for re-payment of the bank note as he was the single member of individual LLC which was he part of. The finance company sued his individual LLC, indirectly him. He settled the note for $50,000 and has a settlement letter from the finance company. The parent company filed bankruptcy under Chapter 11. I am unsure that what would be the tax consequences of these charges paid? Can the client deduct both the attorney fees and settlement paid in his Schedule C? Please suggest.

 

[LdiJ]

Thanks for the replies. Yes, I was able to gather more info in this case. Seems there was a parent company with many LLCs falling under it. My client was a single member in one of the individual LLCs. The parent company took out a note of $500,000 on behalf of each of the individual LLCs and spent the notes. My client was held liable for re-payment of the bank note as he was the single member of individual LLC which was he part of. The finance company sued his individual LLC, indirectly him. He settled the note for $50,000 and has a settlement letter from the finance company. The parent company filed bankruptcy under Chapter 11. I am unsure that what would be the tax consequences of these charges paid? Can the client deduct both the attorney fees and settlement paid in his Schedule C? Please suggest.

Who are you in this scenario? You said "my client". Are you the attorney for the client or a tax professional for the client? If an attorney, you should refer your client to a tax professional. If you are a tax professional, an internet forum is not the correct source for information as it is not "authority".

 

[upcomingcpa19]

You're going to have to explain:

1. What type of bankruptcy.
2. What "settlement" fees you are talking about.

Money paid to settle debts aren't deductible. Certain things like legal/trustee fees MIGHT be

Who are you in this scenario? You said "my client". Are you the attorney for the client or a tax professional for the client? If an attorney, you should refer your client to a tax professional. If you are a tax professional, an internet forum is not the correct source for information as it is not "authority".

I am trying to gather advice. I am a very new CPA and trying to understand the best course of action. Have told the client to call up IRS too, at the day end - IRS guidelines play the authoritative role. I am just trying to understand those guidelines. Thx

 

[Taxing Matters]

Thanks for the replies. Yes, I was able to gather more info in this case. Seems there was a parent company with many LLCs falling under it. My client was a single member in one of the individual LLCs. The parent company took out a note of $500,000 on behalf of each of the individual LLCs and spent the notes. My client was held liable for re-payment of the bank note as he was the single member of individual LLC which was he part of. The finance company sued his individual LLC, indirectly him. He settled the note for $50,000 and has a settlement letter from the finance company. The parent company filed bankruptcy under Chapter 11. I am unsure that what would be the tax consequences of these charges paid? Can the client deduct both the attorney fees and settlement paid in his Schedule C? Please suggest.

I'm having trouble picturing the arrangement given your description of it. How is it that your client was a single member LLC owned by an individual yet was also a LLC "falling under" a parent company, which suggests that other company owned the LLC? What kind of entity was the parent company? And how was it that the parent company took out a loan of $500,000 "on behalf of" its subsidiary LLCs? And do you mean that it took a loan of $500,000 for each LLC, or just one loan of $500,000? If the latter, what share of that loan was your client's LLC liable for?

 

[upcomingcpa19]

Yes, the loan was taken on behalf of each LLC. And finally each LLC paid the lump sum settlement to the lender in lieu of loan + interest. My client’s LLC got the letter from the lender that all the obligations have been settled for, no more claim in lieu of the lower lump sum settlement. The parent Company was managing the operations for all individual LLCs.

 

[Taxing Matters]

Yes, the loan was taken on behalf of each LLC. And finally each LLC paid the lump sum settlement to the lender in lieu of loan + interest. My client’s LLC got the letter from the lender that all the obligations have been settled for, no more claim in lieu of the lower lump sum settlement. The parent Company was managing the operations for all individual LLCs.

Ok, let's get a bit more specific because your facts are still confusing. Let's say that the other company is BCD corporation and your client is XYZ LLC. You use the term "parent" to describe the relationship between BCD and XYZ. In both tax and corporate law the term "parent" would mean that BCD owns all or at least a majority of the interests in XYZ. I suspect that parent is not the word you wanted, but let's clarify things here. Does BCD own any of the interests in XYZ (your client)? If yes, how much? Or is XYZ wholly owned by some individual? (I'll refer to the individual as Adam). You refer to the client using Schedule C, so I'm guessing that Adam is the sole owner of XYZ and therefore that BCD is not the parent of XYZ. Getting the terms right makes a big difference.

If BCD did not own any of XYZ, the exactly what was the relationship between them? You post above seems to suggest that BCD was a company that provided management services to other companies. If that is the case, then I assume that XYZ contracted with BCD to manage XYZ for Adam. Is that correct? If it is, then did Adam actively participate in running XYZ or did BCD handle everything?

Now, about the loan. Did BCD borrow $500,000 just for XYZ? Or was $500,000 borrowed to be spread among several LLCs? If the latter, how much of the loan was XYZ's responsibility? And did BCD use the borrowed funds for XYZ's business?

Why did XYZ get sued for the loan? What was XYZ's liability for it? And how did they arrive at settling for just $50,000?

The details matter here because there may be cancellation of debt income here in addition to the deduction questions you have asked about. If you can clear up what I've asked about I may be able to address the questions you asked.

I don't know how much tax knowledge you have, but this particular situation at least seems a bit beyond your capability and it might be better to refer the client to a tax practitioner who is familiar with business tax issues.

 

[upcomingcpa19]

Yes, the loan was taken on behalf of each LLC. And finally each LLC paid the set

Ok, let's get a bit more specific because your facts are still confusing. Let's say that the other company is BCD corporation and your client is XYZ LLC. You use the term "parent" to describe the relationship between BCD and XYZ. In both tax and corporate law the term "parent" would mean that BCD owns all or at least a majority of the interests in XYZ. I suspect that parent is not the word you wanted, but let's clarify things here. Does BCD own any of the interests in XYZ (your client)? If yes, how much? Or is XYZ wholly owned by some individual? (I'll refer to the individual as Adam). You refer to the client using Schedule C, so I'm guessing that Adam is the sole owner of XYZ and therefore that BCD is not the parent of XYZ. Getting the terms right makes a big difference.

If BCD did not own any of XYZ, the exactly what was the relationship between them? You post above seems to suggest that BCD was a company that provided management services to other companies. If that is the case, then I assume that XYZ contracted with BCD to manage XYZ for Adam. Is that correct? If it is, then did Adam actively participate in running XYZ or did BCD handle everything?

Now, about the loan. Did BCD borrow $500,000 just for XYZ? Or was $500,000 borrowed to be spread among several LLCs? If the latter, how much of the loan was XYZ's responsibility? And did BCD use the borrowed funds for XYZ's business?

Why did XYZ get sued for the loan? What was XYZ's liability for it? And how did they arrive at settling for just $50,000?

The details matter here because there may be cancellation of debt income here in addition to the deduction questions you have asked about. If you can clear up what I've asked about I may be able to address the questions you asked.

I don't know how much tax knowledge you have, but this particular situation at least seems a bit beyond your capability and it might be better to refer the client to a tax practitioner who is familiar with business tax issues.

yes, you are correct. I am still learning the ropes. BCD was just managing XYZ affairs and BCD had taken out the bank loan for $500,000 for XYZ for a software and other office supplies that was never delivered to XYZ. In fact, XYZ claims that it never knew of these transactions and never received the loan proceeds. When lender came knocking on doors to recover the loan, at that time XYZ realized its a ponzi scheme and sued BCD and the lender. Other individual LLCs had the same situation and they also similarly sued BCD and the lender. The grounds of lawsuit was that XYZ wasn’t aware about the loan and claimed that it was fraudulent. Finally, all the parties settled in court wherein XYZ agreed to pay lumpsum amount of $50,000 to the lender in lieu of cancellation of the remaining $450,000 and any other claims from BCD too. My client has the copy of the judgement as well as letter provided by lender for accepting the settlement claim and releasing XYZ from further claims. The client doesn’t have a 1099-C which I already asked him earlier. He provided me complete facts this week only so now I am able to think in appropriate direction. He never claimed any expenses on Schedule C for XYZ neither showed the loan (as he was unaware) so my doubt is how to report the debt cancelled and $50k paid on Schedule C. Also, the main company - BCD filed Chapter 7 bankruptcy. XYZ seems to have an active EIN till date.
Thanks a lot for your inputs, highly appreciated. I am going to refer the client to a senior tax professional too. Just wanted to research on my own too.