Business closing down (Form 1065) - How are partner loans TO the partnership treated for gain/loss calculation?

But what if the partner didn't have formal loan documents? Our partner just transferred money when needed with verbal agreements. Will the IRS still allow the bad debt deduction without promissory notes?

For loans without formal documentation, you can still potentially claim the bad debt deduction, but it becomes more challenging. The IRS wants to see that there was a genuine debtor-creditor relationship with an actual expectation of repayment, not just capital contributions. If you have bank statements showing transfers labeled as loans, emails or texts discussing loan terms, or accounting records that consistently treated these as loans rather than capital contributions, these can help establish the legitimate nature of the debt. Adding an entry in company minutes documenting the loans retroactively (being honest about when they were created) might also help demonstrate the intent.

How exactly does this work? Do they have real tax pros reviewing documents or is it just some AI thing summarizing tax regs? Our situation has some weird complexities with personal guarantees on some partnership debt.

I'm skeptical of these kinds of services. Wouldn't it be better to just hire a CPA who specializes in partnership taxation rather than uploading sensitive financial documents to some website?

It's actually a combination - they use AI to analyze your documents and extract the relevant information, but they have tax professionals who oversee the process and verify the guidance. They were able to identify specific sections in our operating agreement that impacted how we needed to handle the partner loans. For partnership situations with personal guarantees, that's actually where I found it most helpful. They explained how the guarantees affected the at-risk basis calculations for each partner and how that impacted their ability to claim losses. The guidance specifically addressed when a guarantee converts to actual debt and the tax implications.

Wait, this actually works? I thought it was impossible to get through to the IRS these days. How much did it cost? I've been waiting on hold for literally hours trying to get an answer about our partnership's final return.

This sounds too good to be true. There's no way to skip the IRS phone queue - they're notoriously backed up. I'd be very careful about any service claiming they can get you to the front of the line.

It absolutely works - they use a system that continuously redials and navigates the IRS phone tree until it gets through, then calls you when an agent is on the line. It's basically doing what you'd do manually but automated. They don't "skip the line" - they just handle the frustrating part of constantly redialing and waiting on hold. When I used it, it took about 48 minutes before I got connected to an actual IRS agent who specialized in partnership taxation. The agent had no idea I'd used a service to reach them - from their perspective, I was just another caller who got through.

What if our operating agreement doesn't mention loans at all? We operated pretty informally and partners just put money in when needed. Sometimes we called it loans, sometimes capital. Will the IRS just look at the substance of what happened?

If your operating agreement is silent on loans, the IRS will generally look at the substance and intent of the transactions. What matters is how you treated these funds in your books and records consistently over time. If you recorded them as loans in your accounting system, made any interest payments, or had any documentation (even emails) discussing repayment terms, those help establish loan treatment. If you've been inconsistent in how you characterized these funds, that creates risk. For informal operations, the IRS often examines the partnership's tax returns to see if Schedule K-1s and Form 1065 treated the funds as loans or capital consistently over the years.

In our case, we had made partial repayments on partner loans before closing. The partner was able to claim a bad debt deduction for only the unpaid portion. The fact that we had made regular payments actually helped establish that these were genuine loans with intent to repay rather than disguised capital contributions.

This is really helpful advice, especially about getting written confirmation of insolvency from an accountant. I hadn't thought about documenting collection efforts - in our case, we haven't made any formal attempts to collect because it's obvious the partnership has no assets. Should we still send a demand letter or something similar just to have it on record, even though we know it won't result in payment? Also, when you mention the loans being "consistently treated as debt on your books," what if our bookkeeping was pretty informal? We used QuickBooks but didn't always categorize things perfectly. Will the IRS accept corrections to how transactions were classified if we can show the intent was always for them to be loans?

Yes, I'd definitely recommend sending a formal demand letter even if you know collection is impossible. It helps establish that you made a good faith effort to collect the debt, which strengthens the bad debt deduction claim. Keep it simple - just state the amount owed, request payment, and mention the partnership's financial difficulties. The partner's inability to pay will be your documentation that the debt is worthless. Regarding the bookkeeping inconsistencies, the IRS generally allows reasonable corrections if you can demonstrate the original intent. Bank records showing money transferred from the partner to the partnership, any emails or texts discussing repayment, and consistent treatment in tax filings (like reporting the loans on Schedule L of Form 1065) all help support loan classification. The key is showing a pattern of intent to treat these as loans rather than capital contributions. If Mike was expecting repayment and the partnership recorded these as liabilities rather than equity, that supports the loan treatment even if some QuickBooks entries were miscategorized.

This is excellent advice about Form 982 and the insolvency exclusion - I completely overlooked the partnership's side of the debt forgiveness! Just to clarify, when you mention documenting the financial position "before each debt cancellation," does this mean we need separate balance sheets if we're forgiving loans from multiple partners on different dates? Or can we forgive all the partner loans simultaneously as part of the dissolution process and use one insolvency calculation? Also, I'm wondering about the interaction between the insolvency exclusion and any remaining partnership assets. We don't have much, but there might be a few thousand dollars left after paying creditors. Does having any remaining assets affect our ability to claim complete insolvency for the loan forgiveness?