## Facts

- Howard S. Bugbee operated a beer parlor in California and was president and a majority shareholder of the corporation that owned it.
- In 1957, Bugbee met Paul Billings, a customer at the beer parlor, and the two became friends.
- Bugbee and Billings frequently discussed possible business ventures that Billings might pursue, and Bugbee believed Billings could succeed in business.
- Between September 1958 and December 1960, Bugbee advanced (loaned) Billings a total of $19,750.
- The advances were represented by 11 written notes signed by Billings.
- The notes were unconditional, unsecured demand notes and stated interest of about 6%.
- Billings never paid any interest and never repaid any principal.
- During the period of the advances, Billings had little money and was unemployed, and he used some of the money for living expenses.
- Bugbee expected that Billings would repay him, hoping repayment would come after Billings became successful, but repayment was not conditioned on any business success.
- Billings acknowledged that the advances were personal loans and that he was obligated to repay them regardless of whether he succeeded.
- In 1967, Bugbee asked several times that Billings repay the money, but Billings did not do so.
- On his 1966 federal income tax return, Bugbee claimed a $19,750 nonbusiness bad-debt loss, reporting it as a short-term capital loss.
- The Commissioner determined a deficiency for 1966 and disallowed the deduction on the ground that Bugbee had not shown a bona fide debtor–creditor relationship.

## Issues

1. Whether Bugbee proved that the advances to Billings created a bona fide debtor–creditor relationship (rather than gifts), so the loss could be treated as a nonbusiness bad debt under I.R.C. § 166(d).
2. If a bona fide debt existed, whether Bugbee was entitled to deduct the amount as a short-term capital loss for 1966 on the theory that the debt became wholly worthless.

## Decision

- The Tax Court held for Bugbee on the remaining issue.
- The court found the advances were bona fide loans, supported by written, unconditional demand notes for fixed sums with stated interest and by the parties’ intent that Billings had an obligation to repay.
- The court allowed Bugbee to treat the worthless nonbusiness bad debt as a short-term capital loss for 1966 under I.R.C. § 166(d), with the deficiency to be recomputed accordingly.

## Legal Principles

- A deductible bad debt under I.R.C. § 166 requires a bona fide debt: a valid and enforceable obligation to pay a fixed and determinable sum of money.
- For nonbusiness bad debts, I.R.C. § 166(d) allows a deduction only when the debt becomes wholly worthless, and the loss is treated as a short-term capital loss.
- Whether an advance is a loan or a gift turns largely on the parties’ intent, evaluated through objective evidence such as promissory notes, stated interest, and creditor-like collection efforts.
- Unsecured notes and a borrower’s weak finances do not, by themselves, prevent debt treatment where the documents and conduct show an unconditional obligation to repay.
- An expectation that repayment will come from future success does not make repayment contingent when the borrower’s legal obligation to repay is unconditional.

## Conclusion

Because Bugbee’s advances to Billings were memorialized in unconditional demand notes with stated interest and both parties treated the advances as repayable obligations rather than gifts, the Tax Court found a bona fide debtor–creditor relationship and permitted Bugbee to claim the resulting wholly worthless nonbusiness bad debt as a short-term capital loss for 1966 under I.R.C. § 166(d).


Howard S. Bugbee v. Commissioner, 34 T.C.M. 291 (1975)