100K Up in Smoke

Long time physician client was tired of the grind and he took some time off to start a Jewelry business in a small SE Asian country.

They took him for about 100K in inventory (stones, etc.), equipment, precious metals, and they even ran amok with his credit card. He is also out about $25K in travel expenses.

The client insists that he was "open for business" but had no sales. I seriously doubt he was ever open for business.

If he insists, in writing, that the travel was 100% business, ordinary, necessary, reasonable, etc. and had no element of personal recreation, do you take the travel expenses?

I'm also thinking it's a capital loss reported on Schedule D?

Theft?

Personal theft losses are nondeductible unless they occurred in a disaster zone.

I might ask to see anything that can substantiate a nascent business. Lease agreements, formation of a business entity, insurance, local business licenses.

If he's not able to provide anything, I'd be skeptical considering there is zero gross revenue.

He's so far (just now, pretty much) shown me the images of some finished products and it they look legit. Pretty nice, actually.

Like high end rings and silver things for yuppie biker types, etc.

No sales though.

Yeah, but how does that establish a business? Could just as easily be a collector, or money launderer.

I'm not sure I agree. It's not a new client and he's a successful physician. I don't think he's laundering. He didn't buy all of this stuff for himself - he bought it so he can sell it and make a profit. I just don't think he made it to being "open for business yet".

What I question about his story is the travel - and I hesitate to take a "self employment" related loss because I doubt he was really open for business.

But it smells like a business start up that went south to me.

Was a police report filed?

If it's a theft loss, it's either going to be a business theft loss, an investment theft loss or a personal theft loss.

You're going to have to do the due diligence to figure out which one.

Remember this thread? It is time to prepare his taxes and here's what I've got....

1) The client spent and says he can document hundreds of hours of his own labor in designing jewelry and manufacturing prototypes for the purpose of sale for a profit. He has the work and finished products to show for it.

2) The client shut down his mental health practice specifically to devote his time to running his jewelry business (full time).

2) The client created a complete website and used IG to market and advertise the finished products. I've seen them myself and they look pretty nice, actually. They are high-end rings and other items for urban professional biker types.

3) The client kept books and records and provided financials showing a P&L with typical and reasonable operating expenses.

4) The client, in writing (email), told me that he was open for business and actively seeking sales. He told me that anyone can order the items at any time.

5) He paid a factory in Thailand a sum of money to purchase materials, make, store, and drop-ship the product when ordered by his customers.

6) As it turns out, there was no such factory. It was smoke and mirrors.

I believe the client - none of his story smells fishy to me.

But when I suggest to the client that all he has are lost "start up costs" ....and that all he can take is an investment loss limited to his capital gains and a $3000 loss per year, he becomes very upset, saying that he has read the publications and that he insists he has a 100% business here and thus should get a business (ordinary) loss.

My question is, what is my risk as an EA of taking the ordinary loss position on his tax return? Do I tell him that I will only take an investment loss and he will have to find another preparer?

Opens for business and right off the bat gets scammed out of everything by fraudulent vendors. It's probably a business loss but being right out of the gate makes it seem really odd. Poor guy. Inventory and all that wouldn't be start-up costs though. That'd be legal, documentation, permitting, etc. All the lost inventory would just be business. Maybe even on the 4797 instead of a big sch c loss.

Yes, the facts need to be reasonable and believed. But assuming they are:

A theft is not elective; either it happened or it didn't.
Form 4797 is not used for inventory losses, is it?
If it's a business loss other than a theft, what justifis not putting it on Sch C?
What's the capital asset that would be reported as a capital loss?

Perhaps break down the specific costs. Travel and costs before he was offering product for sale is capitalized as start up, deductible up to a point when business begins. Operating costs are current deductions. The amount paid to the factory is a business casualty loss. Is he going to continue this business? If not, aren't the assets 1231 property, therefore, fully deductible via the 4797?

Len posted while I was typing.

1) The client spent and says he can document... designing jewelry and manufacturing prototypes... He has the work and finished products to show for it.

2) The client created a complete website and used IG to market and advertise the finished products...

4) ...He told me that anyone can order the items at any time.

5) He paid a factory in Thailand a sum of money to purchase materials, make, store, and drop-ship the product when ordered by his customers.

6) As it turns out, there was no such factory. It was smoke and mirrors.

Doesn't it sound like he was no longer in start-up mode, and was open for business if those were truly the sequence of events?

Torres (T.C. Memo. 2021-66) and the other case citations therein are a good read. I believe the laws of the "small SE Asian country" will come into play.

I'm still curious if a police report was filed. Also curious how he paid them? Hopefully not a suitcase of cash...

Also #2: did he consult a local attorney? Perhaps a P.I.? (prospect of recovery?)

I'm going to guess you'll have a much harder time dotting the theft loss "I's" and crossing the "T's" than you will proving he was open for business.

Consider taking an ordinary loss via abandonment.

He's so far (just now, pretty much) shown me the images of some finished products and it they look legit. Pretty nice, actually.
Like high end rings and silver things for yuppie biker types, etc.
No sales though.

6) As it turns out, there was no such factory. It was smoke and mirrors.

It sounds unusual that someone would be so trusting nowadays as to send over a bunch of money to Thailand without ever asking for physical proof of anything before making this investment: no jewellery needed to be send to your client ever. He just believed the photos?

It's strange to go from being a practicing MD to selling jewellery made by some factory in Thailand... Could family be involved? Does client have financial woes? I do not know your client but it sounds very unusual.
I have a client in the jewellery business who sells high-end jewellery ... who sells through known high-end retailers in the US. The jewellery business is not easy to get into. People don't buy a 3K necklace from some Thai website. I made up a figure but 3K is ... not high-end.

Long time physician client was tired of the grind and he took some time off to start a Jewelry business in a small SE Asian country.
They took him for about 100K in inventory (stones, etc.), equipment, precious metals, and they even ran amok with his credit card. He is also out about $25K in travel expenses.
The client insists that he was "open for business" but had no sales. I seriously doubt he was ever open for business.
If he insists, in writing, that the travel was 100% business, ordinary, necessary, reasonable, etc. and had no element of personal recreation, do you take the travel expenses?
I'm also thinking it's a capital loss reported on Schedule D?

It sounds strange. Tired of the grind, you pay 100K to go into an industry you have no knowledge about, you also need no proof that you paid 100K to a legitimate business in Thailand in an industry you have no knowledge about, you see nice online photos of jewelry but please do not send me the actual jewelry, I believe you on your word...

I do not know your client but ... this sounds too weird to be believable.100K ... an industry he didn't know anything about ...no proof needed? Why did your client not invest in a mutual fund?

I work with a number of highly intelligent (high income earners) taxpayers who own no stock market investments. A remarkable number of people don’t trust the stock market. (But not sure if they’d invest $100k in Thailand either…)

It sounds strange. Tired of the grind, you pay 100K to go into an industry you have no knowledge about, you also need no proof that you paid 100K to a legitimate business in Thailand in an industry you have no knowledge about, you see nice online photos of jewelry but please do not send me the actual jewelry, I believe you on your word...

I do not know your client but ... this sounds too weird to be believable.100K ... an industry he didn't know anything about ...no proof needed? Why did your client not invest in a mutual fund?

It happens. Tourists and foreigners get swindled all the time in Asia. Especially SE Asia and India.

A "friendly" person walks up, asks what your name is, what you do, how long you're visiting. Most tourists think the guy is just being friendly and making conversation. Really what he's doing is gauging how much money you have and how long he has to work you.

I'd imagine these guys were working him for weeks or even months.

Pursuit and prospect of recovery does matter with a theft loss. It would look good if, after the discovery, the client engaged a local attorney for a consult and a local private investigator. For $100k, what's another few thousand?

So the good Doctor wants Uncle Sam to underwrite his adventures in Thailand, think if his return is audited, and
you have signed as the Preparer. Could you provide documentation of the actual spending, proof of receipts?
You can see much doubt expressed in establishing a solid case to convince a Tax Court that he acted with the requisite "profit intent". Does he have corroborating testimony to support his story, from anyone credible.
Maybe, just maybe his hiatus from medicine, is to write a best selling novel and you are the 1st-Chapter, "how to get
your Tax Preparer to deduct a 100-grand for you".

I don’t know that a tax preparer’s job is to argue why a deduction isn’t allowed…clients typically hire a tax preparer to help them identify the “legislative grace”…