Where a bad debt results in a loss, Internal Revenue Code (IRC) §166 generally allows a deduction in the year in which the debt is established to be worthless.1 If the person bearing the loss is a taxpayer other than a corporation, however, the character of the loss, and thus the amount of any resulting tax benefit, depends on whether the debt that became worthless is a “nonbusiness debt” or a “business debt.”2

A business debt is “(A) a debt created or acquired (as the case may be) in connection with a trade or business of the taxpayer; or (B) a debt the loss from the worthlessness of which is incurred in the taxpayer’s trade or business.” For this purpose, the concept of “trade or business” implies a degree of regularity of ordinary business activity that goes beyond merely seeking a profit or making an investment. Any debt that is not a business debt is a “nonbusiness debt.”

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