## Facts

- Howard S. Bugbee owned and operated a bar/beer parlor and met Paul Billings there in 1957.
- Bugbee and his wife were of moderate means; Bugbee was not in the business of lending money.
- Over time Bugbee and Billings became close friends, and Billings became godfather to one of Bugbee’s children.
- Billings was largely unemployed, but Bugbee believed Billings had viable business ideas and agreed to advance him funds.
- Between 1958 and 1960, Bugbee advanced Billings a total of $19,750.
- The advances were documented by 11 written, formal promissory notes signed by Billings.
- The notes were unsecured, unconditional demand obligations and provided for interest of at least 6%.
- Billings paid no interest and repaid no principal on any note.
- Bugbee expected repayment when Billings obtained money from a successful venture, but the notes did not make repayment contingent on any venture’s success.
- Bugbee occasionally requested repayment, but he did not take aggressive collection steps and did not investigate Billings’s financial condition before making the advances.
- On his 1966 federal income tax return, Bugbee claimed a deduction treating the $19,750 as a nonbusiness bad debt, reported as a short-term capital loss under I.R.C. § 166(d).
- The Commissioner disallowed the claimed loss and determined a 1966 income tax deficiency (other issues were resolved, leaving only the bad-debt dispute).
- Bugbee petitioned the United States Tax Court, contending the advances were bona fide loans that became wholly worthless in 1966.

## Issues

1. Whether Bugbee’s advances to Billings created a bona fide debtor-creditor relationship (a valid and enforceable obligation to repay a fixed and determinable sum) so that the loss could qualify as a nonbusiness bad debt under I.R.C. § 166(d).
2. Whether Bugbee proved the debt became wholly worthless in 1966, the year for which he claimed the short-term capital loss.
3. Whether Bugbee sufficiently proved the amount of the advances and his status as the creditor for § 166 purposes.

## Decision

- The Tax Court held Bugbee established a bona fide debtor-creditor relationship with respect to the amounts advanced to Billings.
- The court found the 11 written, interest-bearing demand notes reflected an unconditional obligation to repay, supporting loan treatment despite the parties’ friendship and Billings’s weak finances.
- The court determined Bugbee adequately proved the amount of the advances and that he was entitled to claim the loss.
- The court allowed Bugbee’s nonbusiness bad-debt deduction as a short-term capital loss for 1966, with the deficiency to be recomputed accordingly.

## Legal Principles

- A deduction under I.R.C. § 166 is available only for a “bona fide debt,” meaning a debt arising from a debtor-creditor relationship based on a valid and enforceable obligation to pay a fixed and determinable sum of money.
- Whether an advance is a bona fide debt depends on the parties’ intent when the funds were transferred, evaluated using objective facts and surrounding circumstances.
- Written promissory notes, a stated interest rate, fixed principal amounts, demand terms, and an unconditional promise to repay are strong indicators of debt rather than a gift or speculative investment.
- A lender’s expectation that repayment will come from the borrower’s future success does not, by itself, make repayment contingent; the controlling question is whether the obligation to repay is unconditional.
- A close personal relationship between the parties does not bar debt treatment if the evidence shows a real debtor-creditor arrangement rather than donative intent.
- For a nonbusiness bad debt, the taxpayer must show the debt became wholly worthless during the tax year claimed; if so, the loss is treated as a short-term capital loss under § 166(d), subject to the capital loss limitations.
- The taxpayer bears the burden to substantiate the amount of the debt and that the taxpayer is the proper holder of the claim for purposes of the deduction.

## Conclusion

In *Bugbee v. Commissioner*, the Tax Court held that Bugbee’s advances to his friend Billings were bona fide loans because they were documented by multiple written, unsecured, interest-bearing demand notes imposing an unconditional duty to repay a fixed amount; although Billings never made payments and Bugbee expected repayment to come from a successful venture, the court found a true debtor-creditor relationship, accepted 1966 as the year the debt became wholly worthless, and allowed the resulting nonbusiness bad-debt deduction as a short-term capital loss under I.R.C. § 166(d).


Bugbee v. Commissioner, T.C. Memo. 1975-45 (1975)