My husband and I owned an S corporation to which we each had loaned money. The corporation went out of business. Can we deduct the loans?

My husband and I owned an S corporation to which we each had loaned money. The corporation went out of business. Can we deduct the loans?

When a corporation you own goes out of business, you may deduct both investments you made in the corporation for which you received stock as well as unpaid loans.

• Deduct any remaining basis in stock as an ordinary loss up to $100,000 on a joint return if the stock qualifies as Section 1244 stock (the corporation must have been an operating business and not a holding company, and total paid-in capital cannot have exceeded $1 million). If the loss is greater than $100,000, excess amounts are treated as capital losses; they can offset capital gains plus up to $3,000 of ordinary income, with excess amounts carried forward to be deducted in future years.
• Loans made to the corporation are deducted as bad debts. Whether they are business bad debts (deducted as ordinary income) or nonbusiness bad debts (treated as short-term capital losses) depends on the dominant motive for making the loan. If it was to protect your investment, then it is probably a nonbusiness bad debt; if it was to protect your paycheck, then it is usually a business bad debt. Several factors come into play in making this determination, including the size of your investment, the size of your after-tax salary from the corporation, and other sources of income to you.

Caution: If you have been taking losses from the corporation, you may no longer have any basis in the stock or the loans to deduct.