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Old 03-13-2014, 10:04 AM
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Life Insurance Proceeds / Company Loan / Deductibility of Loan not repaid

Kent passed away in September 2008 after a six month battle with cancer. Kent and his wife, Judy, owned a business, DCP which Kent had run prior to his passing. Upon Kent's death, the business was put up for sale with a broker, but after roughly a year had passed, no reasonable offers had been received. Kent's wife, Judy, continued to own and operate DCP for the next several years with roughly break even profitability. Kent had a $200,000 life insurance policy which was collateralized by a bank loan to DCP. The paid down loan balance was approximately $200,000 at the time of Kent's passing. The life insurance proceeds were paid out a few months after Kent's passing and the bank mandated that these funds be placed into a deposit account at the same bank. The bank eventually applied pressure on Judy to use these funds to pay off the loan from the bank as the bank was not happy with the lack of profitability of DCP. The life insurance proceeds were payable to Judy, but Kent had directed to Judy that he would like the proceeds to be split evenly three ways between his wife, Judy and his son, Alex and daughter, Laurie. When the life insurance proceeds were used to pay off the bank loan to DCP, three separate notes payable were drawn up for $66,667 each by Judy, Alex & Laurie to DCP as DCP could not afford to pay back the initial loan to the bank based on the company's lack of profitability and cash flow. The plan was for DCP to pay off these loans when a buyer could be found for DCP. Eventually, DCP was sold in June 2012 by Judy, but at a sizable loss which did not have enough proceeds to pay back the life insurance proceeds loans from Judy, Alex & Laurie to DCP. Are Judy, Alex and Laurie all able to claim these defaulted loans by DCP as losses on their respective tax returns? Could you direct me to any tax literature to answer this question? Thank you

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