Taxpayer asks:
Two years ago, I gave my son a considerable amount of money so that he could finish graduate school without having to take out any student loans. Last year, he announced that he was “taking a break” from school. Since he was no longer going to school, I asked him to give the money back. His girlfriend said that they had already used the money to plan their dream wedding.
I am very angry with my son but I do not want to sue him. It is a lot of money at stake. It is my understanding that I can claim this loss on my taxes by issuing him a 1099. How do I do this?
Taxgirl says:
First of all, my sympathies that things didn’t turn out as you planned. I’m not sure, however, that I’m going to be able to make you feel better.
It appears that what you want to do is treat this as a bad debt. I’m not sure that you can do this since I believe it was a gift. A gift gone bad, perhaps, but a gift nonetheless.
In order for a transaction to be considered a bad debt, you have to be able to prove that it was an actual loan. Under the circumstances as you presented them, I don’t think you ever intended for it to be a loan. I think you gave your son some money as a gift (you even wrote “I gave” and not “I loaned”) and he didn’t use it the way that you intended; my guess is that had your son finished school, you would have never asked for the money back.
That is significant because to claim a bad debt on your taxes, you would have to have proof of a loan (which I’m guessing would be difficult) as well as proof that you’ve made reasonable efforts to collect the debt. It’s worth noting that when it comes to transactions between related parties, the level of proof is generally a bit heightened – the IRS tends to believe that undocumented loans between related parties are really gifts.
Let’s say that you can prove that it’s a loan – you have a promissory note or some other evidence. There are still restrictions on the deductibility. If you’re not in the business of making loans for a living, you have what is referred to as “nonbusiness bad debt.” In that case, the debt must be totally worthless to be deductible. If it is, you report it as a short–term capital loss on your form 1040 at Schedule D; note that it is subject to the capital loss limitations.
When you claim the bad debt, you’ll have to attach a statement to your form 1040 that explains:
- A description of the debt, including the amount and the date it became due (if you have a promissory note, that would be best);
- The name of the debtor – you must include an explanation of any familial relationship (in this case, he’s your son);
- Details of the efforts you made to collect the debt; and
- What event caused you to decide that the debt was worthless.
Finally, the 1099. You’re thinking about the form 1099-C that we’ve been hearing a lot about in the news. It’s a form of “discharge of debt.” The intention of the form is to provide relief for financial institutions for debts larger than $600. It is not intended for individuals to use to settle nonbusiness bad debts.
The form is evidence for the recipient (the debtor – in this case, your son) of the amount to report on his or her personal income tax return. It is provided to the IRS because cancellation of debt is a taxable event. It’s worth noting that irrespective of issuing the form 1099, your son would be required to report the amount of the debt forgiveness on his personal tax return.
I would advise you to discuss this matter with your son. If it’s a bona fide loan, then perhaps you should give him another opportunity to repay the loan by explaining to him exactly what his obligations are. If he’s old enough to get married, he’s old enough to act like a grown up. A grown up wouldn’t act this way towards Bank of America or PNC.
If it is actually a gift gone bad, I would explain to your son how disappointed you are that he has chosen to ignore your wishes. Perhaps, after the fact, he would be willing to work out a payment plan with you to return the money – even if it is a gift. I would think it would be important to him to start out this next chapter of his life with the support and respect of those around him – especially from what seems like a pretty good father who was trying to pay for his education. 
All of that said, good luck. I hope it works out for all of you.
Like any good lawyer, I need to add a disclaimer: Unfortunately, it is impossible to give comprehensive tax advice over the internet, no matter how well researched or written. Before relying on any information given on this site, contact a tax professional to discuss your particular situation.
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