968 F.3d 839
7th Cir.2020Background
- VHC (family-owned company) advanced about $111 million to Ron Van Den Heuvel and his companies from 1997–2013; Ron repaid only ~$39 million and by 2013 VHC had written off ~$95 million as bad debts.
- In 2002–2003 VHC guaranteed Ron’s loans to preserve its line(s) of credit with Associated Bank and other lenders; VHC claims payments were compelled to protect its business credit.
- IRS audited VHC and issued a notice disallowing $92 million of the write-offs; VHC petitioned the Tax Court.
- After a ten-day bench trial the Tax Court found no bona fide debtor‑creditor relationship between VHC and Ron, disallowed the §166 bad-debt deductions, and also rejected VHC’s alternative §162 ordinary-and-necessary business-expense claim.
- The Tax Court allowed a limited reduction for unpaid interest that accrued before 2007 but concluded interest accruals stopped when VHC decided it did not expect repayment; VHC appealed.
Issues
| Issue | VHC's Argument | IRS / Tax Court Argument | Held |
|---|---|---|---|
| Whether payments were "bona fide" debts deductible under I.R.C. §166 | The advances were loans (promissory notes, third-party representations) and thus bona fide debts VHC expected repaid | The parties treated the transfers like investments, routinely extended/renewed or deferred notes, and lacked evidence of intent to enforce repayment | Not bona fide debts; §166 deductions denied |
| Whether payments were deductible as ordinary and necessary business expenses under I.R.C. §162 | Payments were compelled by bank demands to preserve VHC’s credit line and avoid bankruptcy — a business necessity | Records were inconsistent/insufficient; compelled payments are not automatically ordinary in the industry and VHC failed to show the payments were ordinary | §162 deduction denied for lack of substantiation and ordinary/necessary showing |
| Sufficiency of VHC’s substantiation/evidence for deductions | Summary spreadsheets and internal records suffice to prove the expenditures | Self-generated, non-itemized records insufficient; inconsistencies undermine credibility | Tax Court permissibly rejected VHC’s evidence; burden on taxpayer not met |
| Proper treatment of interest accruals once debts found not bona fide | All accrued interest (including paid amounts) should reduce taxable income | Interest accruals ceased in 2007 when VHC concluded repayment unlikely; Tax Court already deducted unpaid interest through 2007 per VHC’s request | Tax Court’s interest adjustments affirmed; no clear error in finding accruals stopped in 2007 |
Key Cases Cited
- INDOPCO, Inc. v. Comm’r, 503 U.S. 79 (1992) (tax deductions are a matter of legislative grace; taxpayer bears burden to prove entitlement)
- Cole v. Comm’r, 637 F.3d 767 (7th Cir. 2011) (Commissioner’s deficiency assessment receives presumption of correctness; burden shifts only in limited circumstances)
- Buelow v. Comm’r, 970 F.2d 412 (7th Cir. 1992) (tax court’s factual finding that taxpayer failed to substantiate a deduction is reviewed for clear error)
- Busch v. Comm’r, 728 F.2d 945 (7th Cir. 1984) (factors indicating intent determine whether a bona fide debtor-creditor relationship exists)
- In re Larson, 862 F.2d 112 (7th Cir. 1988) (distinguishing creditor expectations from investor expectations)
- Lohrke v. Comm’r, 48 T.C. 679 (1967) (tax court may allow deductions for payments made for another when taxpayer shows business purpose and ordinary/necessary character)
- Comm’r v. Lincoln Sav. & Loan Ass’n, 403 U.S. 345 (1971) (compulsory payments are not automatically ordinary and necessary business expenses)
- United Draperies, Inc. v. Comm’r, 340 F.2d 936 (7th Cir. 1964) (taxpayer must show that an expense is a normal incident of the industry)
- Baker Hughes, Inc. v. United States, 943 F.3d 255 (5th Cir. 2019) (discussing limits on deducting payments made for third parties under §162)