Proof a Loan is a Loan

One interesting issue that often arises in IRS audits is whether what a taxpayer classifies as a loan is actually a loan.
The Tax Court recently released an interesting, taxpayer friendly, decision on this matter in Stanley v. Commission, TC Memo 2016-196.


The general rule being:


Courts consider various factors in determining whether the parties intended
a bona fide loan, such as: (1) the ability of the borrower to repay; (2) the existence
or nonexistence of a debt instrument; (3) security, interest, a fixed repayment date,
and a repayment schedule; (4) how the parties’ records and conduct reflect the
transaction; (5) whether the borrower had made repayments; (6) whether the
lender had demanded repayment; (7) the likelihood that the loan was disguised
compensation for services; and (8) the testimony of the purported borrower and
lender. Welch v. Commissioner, 204 F.3d 1228, 1230 (9th Cir. 2000), aff’g T.C.
Memo. 1998-121; Frierdich v. Commissioner, 925 F.2d 180, 182 (7th Cir. 1991),
aff’g T.C. Memo. 1989-393; see also Todd v. Commissioner, T.C. Memo. 2011-
123, aff’d, 486 F. App’x 423 (5th Cir. 2012). The factors are “non-exclusive” and
provide a “general basis upon which courts may analyze a transaction”. Welch v.
Commissioner, 204 F.3d at 1230.


In Stanley, the taxpayer did not even have a plan of repayment, but his testimony that he believed the loan offered a good rate of return, and that he did intend to repay the loan helped meet the above tests. The taxpayer was also able to supply general promissory notes.


When working with loans, its always important that taxpayers document any agreements. I've seen these agreements even documented on a napkin over a dinner deal for a loan.


Relevant Citations: TC Memo 2016-196