The taxpayer in the case of Scheurer v. Commissioner, TC Memo 2017-36 claimed that he either had a large business bad debt loss or a partnership loss related to funds that he stated he had advanced to a business being operating by a friend of his. Unfortunately for Mr. Scheurer, the Tax Court did not accept either claim.

Mr. Scheurer had a friend, Kevin Zinn, who was planning to start a robo-call operation, marketing his company’s services to individuals with high credit card debt. For a fee, the organization (Continental Financial Services, referred to as CFS) would contact the individual’s bank and attempt to negotiate a lower interest rate. If a prospect agreed to hire CFS, the prospect would be charged an upfront fee that would be charged to the prospect’s credit card.

There was one major hitch in this plan. Mr. Zinn had poor credit and was unable to obtain a merchant account in order to receive the credit card payments. Mr. Zinn approached Mr. Scheurer to have him obtain the merchant accounts, since Mr. Scheurer had a significantly better credit history. Mr. Scheurer agreed to do this, forming a partnership with another individual to obtain the merchant accounts through which CFS would receive its fees.

While it was a partnership, Mr. Scheurer was expected to provide all of the capital for the partnership, for which he held a 90% interest. His partner (Mr. Jasikoff) was expected to manage the operations of this entity and prepare financial statements.

CFS ran into financial difficulties rather early on and Mr. Zinn approached the taxpayer to provide additional capital.

The problems with the taxpayer’s case begin here, as the record for what was advanced was rather sketchy. As the Court notes:

First, petitioner alleges that his girlfriend at the time, Jennifer Soden, made wire transfers during 2009 from her personal bank account to CFS in the aggregate amount of $84,000. But she testified that she did not know whether this money went to petitioner, JC, or CFS. Her bank account statements evidence these transfers; but neither she nor petitioner could establish that the account numbers to which the funds were wired belonged to CFS. Ms. Soden clearly advanced these funds to petitioner or on his behalf, because petitioner’s father eventually provided Ms. Soden with enough money to make her whole. But there is no evidence, apart from petitioner’s testimony, that this $84,000 was actually received by CFS.

Second, petitioner alleges that most of the debits to JC’s bank account during 2009 represented loans to CFS. But at least $19,800 of these debits represented payments to Ms. Soden and at least $22,600 represented payments to petitioner; many other debits represented payment of Mr. Jasikoff’s expenses. Most of the other large debits appeared to be amounts that JC remitted to CFS pursuant to its “merchant processing” activity.

Being unable to prove what had been advanced would itself be enough to stop any deduction—but although the Court would later note that it did not find the taxpayer’s testimony convincing, it did find testimony of Mr. Jasikoff credible on one advance:

Mr. Jasikoff credibly testified that on at least one occasion he withdrew cash from JC’s bank account, hand-carried it to Florida, and distributed it to CFS employees when Mr. Zinn could not make payroll. The record includes signed releases from CFS employees evidencing receipt of $19,842 from Mr. Jasikoff.

The Court, finding that the amount that could be documented as paid to CFS was $19,842 then looked to see if a deduction was allowable under either of Mr. Scheurer’s theories.

The Court found two fatal flaws with the attempt to claim a non-business bad debt for the $19,842 advanced which was not repaid. First, the taxpayer could not how that what had been paid over was an actual loan for which payment was reasonably expected. If there was no reasonable expectation of repayment at the time of the advance there was no debt, as a rational lender never would have advanced funds under the terms.

In this case the opinion notes:

There is no evidence to support petitioner’s contention that any funds he advanced to CFS gave rise to a bona fide loan. There was no promissory note, no fixed or determinable amount due, no specified interest rate, no principal due date, and no requirement of security. See Bauer v. Commissioner, 748 F.2d 1365, 1368-1371 (9th Cir. 1984), rev’g T.C. Memo. 1983-120; Estate of Mixon v. United States, 464 F.2d 394, 402-405 (5th Cir. 1972); CMA Consol. Inc., 89 T.C.M. (CCH) at 713-715. It seems obvious that no bank would have lent money to Mr. Zinn or CFS in 2009. Indeed, the reason that Mr. Zinn sought “merchant processing” assistance from petitioner was that his credit was too poor to enable him to open merchant accounts himself.

The only advances to CFS that petitioner substantiated were Mr. Jasikoff’s payment of wages to its employees when Mr. Zinn could not make payroll. But if Mr. Zinn could not pay his debts as they became due, he was very likely insolvent. Because the prospects of repayment from an insolvent person are quite doubtful, this fact strongly suggests that Mr. Jasikoff’s $19,842 advance did not give rise to bona fide debt. See Road Materials, Inc., 407 F.2d at 1125.

As well, to be a business bad debt the debt must arise from a business and be reasonably related to that business. Mr. Scheurer failed that test as well in the view of the Court.

Petitioner was not engaged in the trade or business of lending money during 2009. He worked full time during that year as a financial adviser, and there is no evidence that he ever lent money to anyone else. We find no evidentiary support for the proposition that his alleged loan to CFS was “a debt created or acquired * * * in connection with a trade or business” of lending money in which he was engaged during 2009. See sec. 166(d)(2)(A). Nor was any alleged loan “incurred in the taxpayer’s trade or business,” namely, petitioner’s occupation as a financial adviser. See sec. 166(d)(2)(B).

We find that petitioner’s dominant motivation for advancing funds to CFS was personal, stemming from his longtime friendship with Mr. Zinn. He was fully aware that Mr. Zinn had very poor credit, and it is highly unlikely that he would have advanced funds under these circumstances unless Mr. Zinn had been a close personal friend. Because petitioner’s primary motivation for advancing funds was personal, we find that the advances, to the extent substantiated, were not proximately related to any business in which petitioner during 2009 was engaged.

The taxpayer claimed that if this wasn’t a business bad debt, then he had losses from the partnership of a similar amount. However, the taxpayer had not originally filed a partnership return or reporting any partnership activity on his Form 1040 for 2009.

In 2014 the taxpayer had a partnership return prepared which showed significant losses for 2009.

Although the partnership formation documents provided it was being formed for the purpose of “providing merchant processing services primarily for, but not limited to,” CFS, he now claimed that the partnership was formed to perform robo-calling services and had merely hired CFS as an independent contractor to perform the services. Most the loss for that year came from “prepaid expenses” written off during the year, with the opinion noting:

These “prepaid expenses” corresponded to the funds that petitioner or JC had allegedly advanced to CFS to cover its payroll and other operating expenses, i.e., the same advances that formed the basis for the bad debt deduction that petitioner claimed on his individual return.

The Court did not find this “partnership” theory any more convincing than the bad debt one. As the opinion holds:

JC clearly was not in the “robocalling” trade or business; that business was conducted exclusively by CFS and its 30 to 40 employees. The partnership agreement between petitioner and Mr. Jasikoff stated that the partnership was being formed for the purpose of “providing merchant processing services primarily for, but not limited to, [CFS].” The agreement recited no other purpose, and “merchant processing” was the only business that JC ever conducted. Petitioner thus has the relationship precisely backwards: It was CFS that hired JC as an independent contractor to act as CFS’ agent in setting up merchant accounts to facilitate CFS’ “robocalling” business.

Since CFS was the business actually in the robo-calling business, those expenses were CFS’s. Generally, a taxpayer cannot deduct the expenses of another taxpayer, though the Court noted one exception to that general rule:

That exception applies where: (1) the taxpayer’s motive for paying the other’s obligation is to protect or promote the taxpayer’s own business and (2) the expenditure is an “ordinary and necessary expense” of the taxpayer’s business. Lohrke v. Commissioner, 48 T.C. 679, 688 (1967); Fargo v. Commissioner, T.C. Memo. 2015-96, at *26; Dietrick v. Commissioner, T.C. Memo. 1988-180, 55 T.C.M. (CCH) 706, 711-712, aff’d, 881 F.2d 336 (6th Cir. 1989).

But the taxpayer failed to show that the partnership met this exception, with the Court noting:

Petitioner did not carry his burden of proving that JC's motive for defraying CFS' payroll expenses was to promote JC's own business. Petitioner's strong personal motivation for helping Mr. Zinn greatly suggests that this advance was a gift or capital investment, not a business expense. And CFS' dire financial situation made it unlikely that JC would have an ongoing "merchant processing" business to promote. See Dietrick, 55 T.C.M. (CCH) at 711-712. Because petitioner has not established that JC's motive for paying CFS' expenses was to protect or promote its own business, we need not address whether the expenses were ordinary and necessary expenses of JC's business. We conclude that petitioner is not entitled to any partnership loss deduction for 2009 because he did not prove the existence or amount of such a loss.