He’s a real family man – but court denied deduction

A recent case demonstrates the difficulties involved in securing a tax deduction from transactions between related parties.

Bad debt deduction

In 1990, Robert Alpert established two irrevocable trusts to fund his two sons’ educations. In 1996, he established a third trust for the benefit of his sons.

Between 1990 and 1996, Alpert transferred $1.1 million to the trusts. In January 1996, the trustee of each of the trusts signed a promissory note to Alpert. No funds were actually transferred in connection with the promissory notes.

Rather, the amounts stated as owed approximated the net funds Alpert had previously advanced to each trust. Subsequently, Alpert continued to transfer moneys to the trusts, but no additional promissory notes were executed.

In 2006, Alpert reported a $1.9 million nonbusiness bad debt deduction on account of worthless debts owed him by the 1990 trusts.

The IRS argued that Alpert was not entitled to the bad debt deduction because he did not establish that:

In concluding that the transfers were not bona fide debts, the court noted that:

  • The beneficiaries of the trusts were Alpert’s sons.
  • There was no written agreement with respect to the majority of the transfers.
  • There was no evident plan of repayment.

The court then said that, even if the transfers represented bona fide indebtedness, Alpert failed to establish that he was the creditor in 2006. Finally, the court found that Alpert failed to show that the debts became wholly worthless in 2006, particularly since the trusts were not insolvent.

Indemnification loss

Alpert was the founder of Aviation Sales Co. (AVS), a publicly traded company. He also had trading authority over his mother’s brokerage accounts.

Acting without his mother’s knowledge, Alpert purchased AVS shares for her at a cost of $2 million. The share price of AVS declined precipitously, and when Mrs. Alpert learned of the purchases, she threatened to sue.

Alpert orally promised his mother that he would cover any losses she incurred if she sold the AVS shares at a loss. In exchange, she agreed that he would share in half of any profits if the shares were sold at a gain. Those promises were later memorialized in a letter.

In 2006, Alpert reported a loss, which he identified as “Indemnification Payment to G. Alpert.” Alpert contended that he was entitled to a loss for his indemnification payments because:

  • His trade or business involved acquiring majority ownership positions in distressed companies, improving their operations and profitability, and taking them public;
  • In so doing, he sought out and enlisted other investors for the purpose of acquiring these companies; and
  • The indemnification agreement with his mother was part of that business process.

In rejecting Alpert’s argument, the court said that the indemnification agreement and the losses stemming from it were not incurred in his business activities. The court said that it was clear from the letter agreement between Alpert and his mother that he was trying to protect himself from liability for mismanagement of his mother’s assets, not from his business activities. (Robert Alpert v. Commissioner, TC Memo 2014-70, April 17, 2014)